By: Swetha Gopalakrishnan and Khadjiah Kenyatte

Private foundations and public charities are both tax-exempt 501(c)(3) organizations established to support charitable causes. However, the organizations differ in how they are funded and operated. Public charities must receive at least one-third of their funding from the public, while private foundations are typically funded by a single individual, family, or corporation.

What is a private foundation?

A private foundation is a non-profit entity with a charitable purpose that assists and benefits the public, such as relief for the poor, educational advancement, or community restoration. Private foundations are usually funded by a single individual, family, or corporation that receives tax deductions for donations.

Typically, the profit or income from an initial investment is used toward the foundation’s charitable purpose. This can provide a stable source of funds and make it easier for private foundations to forecast spending than it is for public charities. Private foundations typically give funds to public charities instead of conducting their own charitable activities.

Private foundations usually require a larger upfront financial investment than public charities. Founders should also note that legal fees are higher for private foundations.

Fundraising is allowed for private foundations, but because they get most of their funding from a single source, they typically do not engage in fundraising. This funding structure also gives private foundations more autonomy to decide where to invest their funds.

taxation at private foundations

Private foundations are tax-exempt if they have a true charitable purpose[1]. It is important to consult with an experienced attorney to ensure your private foundation has a charitable purpose and qualifies for all relevant tax exemptions.

To maximize tax benefits, founding members should invest 30% of their pre-tax income into their private foundation. By contributing to the foundation regularly, individuals can save up to 46% on their estate taxes. Savings above that amount can be “carried over” for up to five years.

Taxation can be more complicated for private foundations than for public charities. Private foundations have complex mandatory Form 990-PF tax filing forms, lower tax deductibility limits for donors, and a minimum of 5% required annual asset distribution to charity each year.

flexibility and control

Private foundations provide more control for those operating the organization than do public charities. They can make investment decisions, determine the organization’s mission, decide what causes to support, and appoint members to the board.

Private foundations also enjoy more flexibility in pursuing their missions. They may:

• Support US public charities.
• Provide direct funds to individuals facing disasters and hardship.
• Award scholarships to recipients of their choosing.
• Give to international causes.
• Lend money to and invest in for-profit businesses.
• Operate their own charitable programs.

how do public charities differ?

The primary difference between private foundations and public charities is how they are funded. While private foundations are usually funded by one individual or organization, public charities must receive a minimum percentage of their funding from the public.

To maintain their tax-exempt status, public charities must prove that they either:

• Receive at least one-third of their funding from small donors who each provide less than 2% of the organization’s total income.
• Meet the facts-and-circumstances test. This means they are at least 10% funded by the public, and meet other subjective criteria related to serving the public interest.

Public charities also have the flexibility to receive funding from private foundations and other public charities. While private foundations typically make grants, public charities primarily perform charitable activities and services.

Because they must serve the public interest, public charities must have a board of directors that are diverse. More than 50% of the members of the board at a public charity must not be related by blood, marriage, or business ties.

Most active 501(c)(3) organizations are public charities. Entities that automatically qualify as public charities include churches, public schools, and hospitals. Other organizations should consult with their trusted Chugh, LLP attorney to ensure that they qualify for public charity status.

tax benefits for public charities?

Compared to private foundations, public charities provide higher tax-deductible giving limits to donors. Additionally, individuals who give to public charities can tailor their tax strategies for giving based on their personal preferences. At an organizational level, public charities enjoy more flexible tax filing requirements.

conclusion

The primary difference between private foundations and public charities is how they are funded. Benefits of each organization type vary based on its founders’ mission and goals. Contact your trusted Chugh, LLP attorney to discuss how best to structure your 501(c)(3) nonprofit entity.

[1] Internal Revenue Code Section 501(c)(3).