Public Charity Vs Private Foundation – Understanding the Differences
Tonight’s title fight: In the red corner, 948,954, representing more than half of all 501(c)(3) organizations, are public charities. And in the blue corner, numbering 108,594, up 54% since 1998, are the 501(c)(3) known as private foundations. Both competitors bring a long and varied history to the ring. Although greatly outnumbered by public charities, private foundations bring a lot to the competition. Let’s take a closer look at the differences and similarities between these title contenders.
Many people have a common understanding of the difference between public charities and private foundations: public charities are understood to carry out charitable work, while private foundations support the work of public charities. That base definition is, in practice, mostly true. The details, however, are a bit more complicated.
Public charities. Public charities represent the majority of active 501(c)(3) organizations. Those starting a new organization generally prefer public charity status, not least because it better describes the organization’s purpose. Public charities also enjoy some advantages over private foundations: higher tax-deductible donation limits from donors, the ability to attract support from other public charities and private foundations, as well as a $25,000 income threshold for charities. activate the annual filing of Form 990 (private foundations file Form 990-PF regardless of income). In fact, an applicant for 501(c)(3) status must demonstrate why it should be considered a public charity, unless a private foundation is considered by default.
Like the definition of the layman, public charities often carry out some form of direct charitable activity. Examples include churches, private schools, homeless shelters, etc… the list of possibilities is almost endless. However, the true definition of a public charity goes well beyond programs and into the realm of structure and source of revenue. In terms of structure, to qualify for (and maintain) public charity status, a 501(c)(3) must be organized exclusively for 501(c)(3) purposes. The IRS requires that certain language be in a public charity’s articles of incorporation explicitly restricting its activities to such. Additionally, a public charity must represent the public interest by having a diverse board of directors. More than 50% of the board must not be related by blood, marriage or outside business co-ownership and not be compensated as employees of the organization. We often get asked where that is in the “code” and frankly, it’s not there… at least not word for word. It is an extrapolation of the IRS requirement that the governance of a public charity be impartial and without (naturally) private benefit to members. As such, the IRS requires that a quorum of non-vested board members be possible, either directly or potentially through a relationship. Finally comes proof of income or source of income. Public charities must be supported by the general public. For that to be true, a significant amount of revenue, at least 33%, must come from relatively small donors (those who contribute less than 2% of the organization’s revenue), other public charities, or the government. While that’s significant, that leaves 67% potentially from other, less diverse sources.
Private foundations. While being considered a private foundation could simply be an alternative position of not qualifying for public charity status through the organizational or income test (or both), more often than not it is a choice that is made. There are reasons why someone would choose foundation status over public charity. Chief among them is control. In exchange for somewhat disadvantageous deductibility limits for donors, mandatory Form 990-PF filings, and minimum annual distributions of assets (5% each year), private foundations can be controlled by related parties and funded by a relatively small group. .. individual or family (think Bill & Melinda Gates Foundation). This is usually more than enough compensation for those starting a foundation. One thing that is no different for private foundations is the requirement that they be organized solely for charitable purposes.
There is even a third type of 501(c)(3), the private operating foundation. This is best viewed as a hybrid of the other two, most often a private foundation with direct program services such as those operated by public charities. The rules are strict, as control can be like that of private foundations, but with some of the benefits of public charities. There are relatively few of these organizations around. You usually only see them in pretty unique circumstances.
At the end of the contest, it is a tie. There really is no winner. It completely depends on the programs, plans and intentions of each organization. Ding Ding!