Article
How private foundations differ from public charities
April 19, 2021 · Authored by Pam Alexanderson
Have you ever wondered what the differences are between a private foundation and a public charity?
Most people are familiar with charities from which they receive a tax deduction, but they often don’t know charities are classified into two types: private foundations and public charities. Understanding the major differences between the two is critical, given the way they affect donor-contribution limits, minimum distributions, public scrutiny, and more.
This article will take an in-depth look at the differences between private foundations and public charities to help you understand the classifications, benefits, and limitations of each one.
It covers the following topics:
What is the difference between a private foundation and a public charity?
Discerning the difference between public charities and private foundations can be confusing because many public charities refer to themselves as foundations, even though there are technical differences between the two.
Public charities
The most common type of charitable organization is a public charity. Some institutions are automatically classified as public charities, for example universities, churches, and research organizations. For other tax-exempt organizations to qualify as a public charity, they must meet one of the following criteria:
- Have broad public support, demonstrated by passing a public support test in the current or prior year
- Pass stringent organization and operation tests to be classified as a supporting organization
Public support tests
These types of organizations are publicly supported by receiving donations or program service revenue from a broad base of donors, clients, or customers. In general, a public charity needs to receive at least 33.3% of its funds from the general public to qualify; in certain circumstances, a charity can pass the test with only 10% public support. Each test is calculated over a 5-year period.
There are two public support tests, and each test has its own definitions of what is considered the general public:
- The first test is for organizations that rely on donations as their main source of support. The test is passed when donations come from a broad base of donors, government grants, and other donation-based public charities.
- The second test is for organizations that have significant program revenue. The test is passed when this program service revenue comes from a broad base of clients or customers, rather than a handful of payors or contracts.There’s also a limitation on how much investment income can be received.
If a public charity fails its support test, it has the option of qualifying under the other test, or as a supporting organization if those tests can be met. If no public support or supporting organization test can be met for two years in a row, the organization becomes a private foundation. It’s still a tax-exempt charity under
Why is the term foundation potentially confusing?
There are many charitable organizations with the term foundation in their name; including that term is often meant to inspire a call to action. However, the IRS has very specific definitions for its use.
IRS Regulation Section 1.509(a)-1 defines a private foundation as any domestic or foreign organization described in IRC Section 501(c)(3) other than an organization described in IRC Section 509(a)(1), (2), (3), or (4). Organizations that fall into the categories under IRC Section 509(a) generally are publicly supported, and therefore called public charities.
The only foolproof way to know what type of charitable organization a foundation is would be to check the IRS database search tool.
Benefits from a donor's perspective
Whichever charitable vehicle is used to conduct philanthropy, it’s important to choose the right one to accomplish your philanthropic goals.
Contributions to public charities and private foundations are both tax deductible. However, public charities have higher tax-deductible giving limits and are more likely to allow for a fair market value deduction rather than tax basis.
Donations to private non-operating foundations are generally limited to 30% adjusted gross income (AGI) limitation for cash donations and 20% AGI limitation for all others. Noncash donations are generally subject to the donor’s tax basis, except for publicly traded stock for which market value is deductible.
Donations to public charities and private operating foundations, on the other hand, generally use market value to determine the tax deduction and higher AGI limits — 50% to 100% for cash and 30% for noncash donations. Contributions of personal property to public charities are also allowed a market value as long as contributed properties are used by the charity in its exempt purpose.
Donor anonymity
Public charities aren’t required to publicly disclose the names and addresses of their contributors, which means the annual tax filings available on GuideStar don’t disclose donor names or addresses.
In contrast, private foundations are required to make their donor information available to the public, so their tax returns, which are also available on GuideStar, list every donor and address for contributions greater than or equal to $5,000.
Benefits from an organizational perspective
Receiving grants
An organization that is classified as a public charity has great potential for receiving grants from the government, private foundations, and the general public.
A private foundation can also receive grants, but donors may be more reluctant to give because the governing board is typically made up of a close group or family instead of various community representatives.
Public scrutiny
Many public charities are heavily supported by the public, which means they’re subject to more public scrutiny than private foundations to help encourage appropriate conduct. There are many different types of public charities, not all are required to be supported with public money.
Private foundations are generally governed by a smaller group, which means they’re subject to burdensome rules and regulations — as well as potential excise taxes — to help allow proper operation. These rules regulate areas such as:
- Self-dealing
- Minimum distributions
- Excess business holdings
- Jeopardized investments
- Taxable expenditures
If a foundation discovers it’s failed to follow regulations, excise taxes are payable by the organization and possibly by foundation managers or founders if the act was known. Often, excise taxes are abatable if there’s reasonable cause, but self-dealing penalties are always paid by the person who committed the act and aren’t ever abatable.
Minimum distributions
Public charities generally spend their money on running charitable programs or providing grants for charitable purposes. They don’t have a required expenditure amount each year and are instead regulated by the general public. For example, the general public is often reluctant to donate to a public charity that isn’t making enough charitable expenditures, unless it’s building up money for a specific program or asset, such as a capital campaign.
Private nonoperating foundations are required by law to distribute approximately 5% of the average market value of their nonexempt use assets, typically investments, each year.
The information provided here is of a general nature and is not intended to address the specific circumstances of any individual or entity. In specific circumstances, the services of a professional should be sought. Tax information, if any, contained in this communication was not intended or written to be used by any person for the purpose of avoiding penalties, nor should such information be construed as an opinion upon which any person may rely. The intended recipients of this communication and any attachments are not subject to any limitation on the disclosure of the tax treatment or tax structure of any transaction or matter that is the subject of this communication and any attachments.