Form 990 Article Series 04: Private Foundation Vs. Public Charity

This is the fourth article in a nine-part series. Read our first 3 articles: Nonprofit Compliance Checklist, How to Review the Form 990, and Nonprofit Lobbying

The IRS classifies all 501(c)(3) nonprofits as either public charities or private foundations. The category into which your organization falls determines how strict your operating rules and regulations are, as well as the type of Form 990 you complete.

Public, Private… What’s the Difference?

Both types of organizations are classified as nonprofits. The difference lies in source funding and transparency. A public charity generally solicits and receives support from the general public, while a private foundation usually receives funding from a single or a few individuals, families or businesses. As a result, private foundations generally have smaller bases of support and a lack of public supervision of its activities. Churches, hospitals, schools, and broadly publicly supported organizations are usually not considered private foundations because of the public nature of their work and wide donor base.

There are also private operating foundations – organizations that devote most of their earnings and assets directly to the conduct of their tax-exempt activities. In contrast, nonoperating foundations normally make grants to other organizations that in turn conduct tax-exempt activities (rather than conducting the activities on their own). Private operating foundations are often thought of as a hybrid between the two categories; this is because they are sometimes governed as a public charity (e.g., donations to operating foundations are eligible for the 50% charitable contribution deduction limitation) but are also subject to some of the same restrictions that apply to nonoperating foundations.

Public charities file Form 990 or Form 990-EZ; private foundations (whether operating or nonoperating) file Form 990-PF.

Advantages of Each Category

An organization classified as a public charity is entitled to several benefits that are not available under private foundation status:

• Public charities are not subject to the private foundation excise taxes.
• Charitable contributions to public charities are governed by less restrictive rules than contributions to private foundations.
• Public charities may engage in limited lobbying activities, while private foundations cannot.

Private foundations also enjoy certain benefits not shared by public charities. For example, their reduced donor base means that they have fewer people to “answer to” regarding their activities. This gives them more freedom to ignore public opinion when supporting causes or projects that others may deem controversial.

Qualifying as a Public Charity

All Section 501(c)(3) organizations are assumed to be private foundations unless they qualify for public charity status under one of the following exceptions:

• A church or a convention or association of churches
• An educational organization that normally maintains a regular faculty and curriculum and has a regularly enrolled student body in attendance where its educational activities regularly take place (i.e., a school or college)
• An organization whose principal purpose or function is providing medical or hospital care or medical education or research
• Educational endowment funds
• A state or possession of the United States (or any political subdivision of these), the United States, or the District of Columbia
• An organization that normally receives a substantial part of its support (exclusive of income received in the performance of its exempt function) from a governmental unit or from direct or indirect contributions from the general public
• An organization that usually receives more than one-third of its support from any combination of gifts, grants, contributions, membership fees, and gross receipts from activities related to its exempt purpose, but receives one-third or less of its support from gross investment income and unrelated business income (net of any unrelated business income tax)
• An entity that is (a) organized and operated exclusively for the benefit of, to perform the functions of, or to carry out the purposes of one or more organizations; (b) operated, supervised, or controlled by or in connection with an organization; and (c) not controlled directly or indirectly by disqualified persons
• An organization organized and operated exclusively for testing of public safety

If the organization does not meet any of these criteria, it is considered a private foundation.

Monitoring Your Organization’s Status

If you qualify as a public charity, it doesn’t mean that you’ll always be one; the criteria for this classification are applied on an ongoing basis, so your status can change over time. So it is important to monitor your organization’s donor base, activities and general situation to ensure compliance with those criteria.

For instance, an entity classified as a public charity due to wide ranging public support may become a private foundation if that support shifts to only a few individuals. If your organization is a public charity for that reason, keep track of your level of public support to ensure that you’re maintaining the necessary ratio of public support.

There can be steep costs to not following the rules governing private foundations. Noncompliance with minimum qualifying distributions rules results in the assessment of an excise tax of 30% on undistributed income. If the required distribution is not made by the close of the following tax period, the excise tax increases to 100% of remaining undistributed income. Note that payment of the excise tax is in addition to, not in lieu of, making the required distributions. If your organization is determined to be a private foundation, make sure to monitor its charitable distributions to ensure that they meet minimum calculated thresholds.

The categories of private foundation and public charity have a direct impact on your financial reporting, including Form 990. With our vast experience in preparing this form and with nonprofits in general, James Moore can help you make this important determination and ensure that you’re complying with all of the applicable regulations – regardless of whatever category applies to you.

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