Differences Between Private Foundations And Public Charities

By Matthew Cadrin | November 23, 2012 AAA
Differences Between Private Foundations And Public Charities

The Internal Revenue Service (IRS) has allowed for the creation of tax-exempt charitable organizations. These groups manifest in one of two ways: as private foundations or as public charities. A private foundation is a non-profit charitable entity, which is generally created by a single benefactor, usually an individual or business. Using this initial seed donation, an investment is made to generate income, which is then dispersed according to the agency's charitable priorities. The range of these priorities must adhere to Section 501(c)(3) of the Internal Revenue Code and includes such areas as: relief for the poor, advancement of education and the combating of community deterioration.

Giving Grants
Private foundations generally make use of grants to individuals or other charities, as opposed to direct funding of their own programs. A public charity, in contrast, tends to carry out some kind of direct activity, such as operating a homeless shelter. The only substantive change between the two is the manner in which funds are acquired. The "public" in "public charity" refers to the solicitation of periodic donations from the community. The amount of these donations is used to determine a quantifiable intensity of public support, which is necessary in order to achieve status as a "public charity."

The exact percentage of revenue that must come from the public has to meet IRS standards, either by a 33 1/3% test or a facts and circumstances 10% test. Therefore, while the foundation uses the income generated from its investments and its founding source, the public charity uses the publicly collected funds to directly support its initiatives. This difference in funding factors into the decision regarding which form the charitable organization might take. Many investment products are able to offer a stable and consistent rate of return (think of your own savings account). Therefore, the endowment structure of private foundations provides a consistent, stable and reliable source of continuing funds. This is important, as budgeting and funding decisions can be made with greater confidence. This has the effect of ensuring timely and efficient access to the aid the foundation seeks to provide.

Ignoring Public Opinion
The chief criticism of private foundations comes from their operational independence. Their private funding source allows them to ignore public opinion and possibly support socially contentious projects. In addition, without the guiding influence of the market, they may generate less-than-optimal outcomes by focusing efforts incorrectly. Private foundations also have more mandatory paperwork (to ensure appropriate use of funds) as well as minimum asset distribution requirements (5% each year). Some might consider public charities more desirable because they have to solicit donations from the community on a regular basis, and thus have to appeal to public sentiment. Additionally, a "market for charity" is created, as each organization strives to capture an individual's contribution.

Public Interest
Both of these forces help compel public charities to work in the wider public interest for the sake of funding, as opposed to the potentially niche issues catered to by private foundations. Concerning taxes, public charities generally have higher donor tax-deductible giving limits as well as the ability to attract support from other public charities and private foundations. From an individual perspective, public charities are desirable due to the flexibility accorded in making donations. This allows for the customization of tax strategies, tailored to personal preference. Establishing a foundation often requires a larger upfront commitment of income, both to start the foundation and to pay legal fees.

In order to get the largest income tax deduction possible, 30% of your pre-tax income should go into the foundation. Through regular contributions, an individual could save up to 46% on his or her estate taxes, with any excess being allowed to "carry over" for up to five years. The chief benefit of operating a foundation comes from the degree of control available. The person responsible for running the foundation can decide who or what to support and can make the investment decisions. At the end of the day, both are useful vehicles for providing charitable services and the differences are a matter of inches rather than miles.

The Bottom Line
If you simply want to get the most out of your tax-deductible giving, donate to one of the many public charities on offer. If, however, you wish to leave a legacy, have a large chunk of cash (say from an inheritance) or a highly valued estate that you would like sheltered from taxes, then a private foundation might prove useful.

Related Articles
  1. The Top Nonprofit Organizations
    Taxes

    The Top Nonprofit Organizations

  2. How To Start Your Own Private Foundation
    Personal Finance

    How To Start Your Own Private Foundation

  3. Microfinance: What It Is And How To ...
    Entrepreneurship

    Microfinance: What It Is And How To ...

  4. 5 Good Reasons To Build A Career In ...
    Personal Finance

    5 Good Reasons To Build A Career In ...

  5. An Introduction to Microfinance
    Insurance

    An Introduction to Microfinance

Trading Center