DEFINITION of 'Private Foundation'

A private foundation is a charitable organization that, while serving a good cause, might not qualify as a public charity by government standards. A private foundation is a nonprofit organization that is usually created via a single primary donation from an individual or a business and whose funds and programs are managed by its own trustees or directors. As such, rather than funding its ongoing operations through periodic donations, a private foundation generates income by investing its initial donation, often disbursing the bulk of its investment income each year to desired charitable activities.

BREAKING DOWN 'Private Foundation'

Private foundations generally fit into two categories: private operating foundations and private non-operating foundations. Private operating foundations actually run the charitable activities or organizations they fund with their investment income, while private non-operating foundations simply disburse funds to other charitable organizations.

How Private Foundations Are Classified by the IRS

If an organization qualifies for tax exemption per section 501(c)(3) of the Internal Revenue Code, it may be considered to be a private foundation by regulators unless that organization is better classified under a different category that is explicitly excluded from being called a private foundation. Excluded entities, per the IRS classification, include universities, hospitals, or organizations and their support elements that hat hold wide public support.

Private foundations are only tax exempt, and contributions to them are only deductible, when such organizations and their governing bodies meet the requirements of 501(c)(3) of the Internal Revenue Code.

The majority of domestic private foundations are subject to an excise tax on their net investment income. There may also be taxes for some foreign private foundations that draw gross investment income from sources in the U.S.

The IRS also holds private foundations to a number of other requirements and rules to receive and maintain this classification. For instance, there are restrictions on private foundations that bar self-dealing, or acting for personal benefit rather than for the interests of beneficiaries, between the foundation and substantial contributors. In other words, the administrators of a foundation cannot use their positions to make deals to enrich themselves at the expense of the foundation’s beneficiaries.

Private foundations must distribute income annually for charitable purposes. There are also limits on the private business holdings of such foundations. The investments made by private foundations must also not put at risk the execution of the organization’s exempt purpose. The expenses and assets spent by a private foundation must be towards those purposes.

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