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Private Foundations vs. Public Charities: What’s the Difference?

Both have 501(c)(3) status, but they operate differently

Private Foundations vs. Public Charities: An Overview

The Internal Revenue Service (IRS) has allowed for the creation of tax-exempt charitable organizations through the granting of 501(c)(3) status. These groups manifest in one of two ways: as private foundations or public charities.

Key Takeaways

  • A private foundation is a nonprofit charitable entity that is generally created by a single benefactor, usually an individual or a business, through an endowment of funds.
  • A public charity uses publicly collected funds to directly support its initiatives.
  • The most substantive difference between the two is the manner in which funds are acquired.

501(c)(3) Status

To qualify for tax-exempt charitable status, both private foundations and public charities must exist for one of the following purposes as stated by the IRS: “charitable, religious, educational, scientific, literary, testing for public safety, fostering national or international amateur sports competition, and preventing cruelty to children or animals.”

The IRS goes on to define “charitable” purposes as “relief of the poor, the distressed, or the underprivileged; advancement of religion; advancement of education or science; erecting or maintaining public buildings, monuments, or works; lessening the burdens of government; lessening neighborhood tensions; eliminating prejudice and discrimination; defending human and civil rights secured by law; and combating community deterioration and juvenile delinquency.”

What Is a Private Foundation?

A private foundation is a nonprofit charitable entity that is generally created by a single benefactor, usually an individual or a business. Using this initial seed donation, known as an endowment, an investment is made to generate income, which is then dispersed in the form of grants to individuals or other charities in accordance with the foundation’s charitable purpose.

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 that the foundation seeks to provide.

A chief benefit of operating a foundation comes from the degree of control available. The person responsible for running the foundation can decide whom or what to support and make the investment decisions. The organization’s board of directors can consist entirely of the members of a single family.

However, a chief criticism of private foundations stems from that operational independence. Their private funding source allows them to ignore public opinion and possibly support socially contentious projects. In addition, they may generate less-than-optimal outcomes by focusing their efforts incorrectly. Private foundations also have more mandatory paperwork (to ensure the appropriate use of funds) as well as minimum asset distribution requirements (5% each year).

What Is a Public Charity?

The “public” in public charity refers to the solicitation of periodic donations from the community. The IRS requires that a public charity receive at least one-third of its contributions from the general public or meet the 10% facts and circumstances test. The charity uses the publicly collected funds to directly support its initiatives, such as operating a homeless shelter or providing medical care to the indigent.

Some might consider public charities more desirable than private foundations because they must appeal to public sentiment. Additionally, a “market for charity” is created, as each organization strives to capture an individual’s contribution.

It is necessary for a board of directors to establish that the public charity is not organized nor operated for the benefit of private interests. It also has to form a quorum of independent board members to conduct an official board meeting.

Private Foundation
  • Funded by a single large endowment

  • Makes grants to individuals and organizations

  • More expensive to start

  • High degree of individual control

  • Must distribute 5% of its assets annually

Public Charity
  • Funded by continual donor solicitations

  • Funds direct activities

  • Must prove to the IRS that it is not a private foundation

  • Must be responsible to a diverse board of directors

  • Must receive one-third of its funds from public donations

Key Differences

Acquisition of Funds

The most substantive difference between a private foundation and a public charity is the manner in which funds are acquired. A private foundation is generally funded by an endowment from a single source, while a public charity must continually solicit donations from individuals and organizations. Also, a public charity can receive funds from a private foundation, but not vice versa.

Disbursement of Funds

A second difference is in how the funds are used. Private foundations make grants to individuals or other charities, while public charities use their money to carry out direct activities.

Establishment

Establishing a private foundation usually requires a larger up-front commitment of income, both to start the foundation and to pay legal fees. All charitable organizations at birth are deemed private foundations by default. A public charity then must prove to the IRS that it qualifies to be one.

Control

The board of directors for a private foundation can consist solely of the members of a single family. The board composition of a public charity is reviewed by the IRS to ensure that the members are independent and represent a broad public interest. Public charities must also field a quorum in order to conduct official business.

Tax Purposes

Public charities generally have higher donor tax-deductible giving limits than private foundations. From an individual perspective, giving to public charities is desirable due to the flexibility accorded in making donations. This allows for the customization of tax strategies tailored to personal preference.

With a private foundation, to get the largest income tax deduction possible, 30% of your pretax income should go into its endowment. Through regular contributions, an individual could save up to 46% on their estate taxes, with any excess being allowed to “carry over” for up to five years.

What is 501(c)(3) status?

The Internal Revenue Service (IRS) provides this tax-exempt status only for organizations with certain purposes. Specifically, they are “charitable, religious, educational, scientific, literary, testing for public safety, fostering national or international amateur sports competition, and preventing cruelty to children or animals.”

What is the main difference between a private foundation and a public charity?

The most substantive difference can be found in how they raise funds. A private foundation is usually funded by a single, large endowment of funds that is then used to generate profits through investments. A public charity continually solicits charitable donations from the community. It can even get a donation from a private foundation in the form of a grant, though public charities do not contribute to private foundations.

Do public charities and private foundations alike have a board of directors?

Yes, but the organization of the board is different for each. A private foundation can have a very small board that consists only of the members of a family, with one person, usually the donor, calling the shots. A public charity should have a composition of members where the majority is unrelated.

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 that exist. If, however, you wish to leave a legacy and have a large chunk of cash just sitting around (say from an inheritance) or a highly valued estate that you would like sheltered from taxes, then a private foundation is likely the way to go. At the end of the day, both public charities and private foundations are useful vehicles for providing charitable services, and the differences are a matter of inches rather than miles.

Article Sources

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  1. Internal Revenue Service. “Exempt Purposes — Internal Revenue Code Section 501(c)(3).”

  2. Internal Revenue Service. “Public Charities.”

  3. Foundation Source. “Setting Up a Private Foundation.”

  4. Pittsburgh Tax Review. “The Private Foundation Rules at Fifty: How Did We Get Them and Do They Meet Current Needs?,” Download PDF, Pages 248–253.

  5. Internal Revenue Service. "Private Foundation - "Jeopardizing Investments" Defined."

  6. Internal Revenue Service. "Administrative Expenses Treated as Qualifying Distributions for the Purposes of IRC Section 4942 - Taxes on Failure to Distribute Income."

  7. Internal Revenue Service. “Exempt Organizations Annual Reporting Requirements — Form 990, Schedules A and B: Public Charity Support Test.”

  8. Cornell Law School. "26 CFR § 1.501(c)(3)-1 - Organizations Organized and Operated for Religious, Charitable, Scientific, Testing for Public Safety, Literary, or Educational Purposes, or for the Prevention of Cruelty to Children or Animals."

  9. Internal Revenue Service. "Governance and Related Topics - 501(c)(3) Organizations," Page 3.

  10. Perkins Law. "Quorum Requirements in Nonprofit Bylaws."

  11. Internal Revenue Service. “Exempt Organization Types.”

  12. Internal Revenue Service. “Charitable Contribution Deductions.”

  13. CHUGH LLP. “What Is the Difference Between Private Foundations and Public Charities?

  14. Internal Revenue Service. “Publication 526: Charitable Contributions,” Pages 16–17.

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