Public charities and private foundations operate differently in the nonprofit sector – especially when it comes to raising funds. Public charities cast a wide fundraising net while private foundations are funded by a single source or a small group of related parties.
Public Charities Overview
The most visible and well-known form of 501(c)(3) organization is the public charity. Churches, hospitals, schools, and cultural venues are a few examples.
Characteristics of Public Charities
Diverse Funding Sources
Public charities solicit funds from governments, businesses, other charities, and the general public. They are required to show the IRS that a significant percentage of their revenue originates from a diverse donor base. The Form 990 (annual tax form for certain 501c organizations) includes a “public support test.” If an organization falls below 33 1/3% public (aka diverse) support, it risks being converted to private foundation status.
Flexibility in Operations
Public charities have more flexibility in grantmaking and general operations than private foundations. Additionally, while public charities do have to monitor and report certain transactions with employees, board members, and significant donors, they typically have less exposure to excise taxes related to transactions with interested persons compared to private foundations.
Board of Directors
Public charities are run by a board of directors who represent general public interests. Ideally, the board consists of independent members representing different points of view to prevent control by one interest.
Private Foundations Overview
While there are some examples of well-known private foundations, many of these organizations operate more quietly than public charities. In recent years there has been an increase in for-profit organizations creating team member assistance foundations to help employees facing financial crises – this type of organization in particular has raised the visibility of the public charity vs. private foundation dichotomy.
Characteristics of Private Foundations
Narrow Funding Sources
Private foundations are funded differently from public charities. Usually funded by a single source or a small group of related parties, these organizations face stricter regulations from the IRS to avoid becoming tax shelters for donors.
Minimum Distribution Requirements
Private non-operating foundations are required to distribute 5% of their net assets annually for charitable purposes. The IRS has specific technical definitions for “charitable purpose.” Private foundation managers need to be aware of the definitions so that charitable activities count towards the 5% distribution requirement. Meeting this requirement requires proactive tax planning and good internal documentation processes.
Taxes on Investment Income
Private foundations pay a 1.39% tax on net investment income.
Control and Governance
In most cases, the donor or founding organization of a private foundation maintains major influence over its activities. Usually consisting of family members, close friends, or employees, the board of directors of a private foundation is not tasked with representing the general public in the same way as a public charity board of directors.
