By: Alyssa Ziegenhorn Are you interested in forming a tax-exempt nonprofit corporation, or applying for tax-exempt status for your existing nonprofit? Nonprofit entities can file Form 1023 with the IRS to request exemption from taxes under Section 501(c)(3) of the Internal Revenue Code because of the charitable programs or actions they undertake. Tax-exempt status comes… Read More
By: Alyssa Ziegenhorn
Are you interested in forming a tax-exempt nonprofit corporation, or applying for tax-exempt status for your existing nonprofit? Nonprofit entities can file Form 1023 with the IRS to request exemption from taxes under Section 501(c)(3) of the Internal Revenue Code because of the charitable programs or actions they undertake. Tax-exempt status comes with many benefits, but it can be tricky to get approval.
Here we will discuss a very important distinction between the two types of classifications on the application: private foundations and public charities. Having a clear picture of which classification you are requesting will help you avoid potential pitfalls on the application. This means your application can be approved much more quickly. It is standard procedure for the IRS to classify an initial 501(c)(3) request as a private foundation rather than a public charity, although they don’t officially publicize that stance. So what is the difference between the two?
1. Private Foundations
When applying for 501(c)(3) status, the IRS will recognize qualifying nonprofits as a private foundation by default, unless cause is shown and a request made that it should be approved as a public charity. Private foundations are typically established by an individual, family, or corporation to support charitable activities.
Funding Source and Spending
Funding for private foundations usually comes from an individual, a family, or a corporation, who then receives a tax deduction for donations. Private foundations are not required to prove that their funding comes from the public. Private foundations are not prohibited from public fundraising, but it is uncommon.
Private foundations usually make grants to public charities, although they can sometimes conduct their own charitable activities.
Because a private foundation is usually closely controlled by an individual, family, or organization, they retain much greater control of the organization. They get to choose the mission, how to invest the funds of the foundation, how to spend those funds, and who is included on the foundation’s board. Private foundations can be governed solely by donors or a board made up of family members and individuals chosen by donors, regardless of relationship to each other and/or the foundation.
Private foundations are required to file Form 990-PF, a tax return form which includes the private foundation’s assets, financial activities, trustees and officers, and a complete list of grants awarded for the specified fiscal year, including the recipient’s names, locations, and grant amounts. At least 5% of the private foundation’s assets must be given to charitable causes each year.
2. Public Charities
To be recognized as a public charity as opposed to a private foundation, the applicant must specifically request public charity status and be able to demonstrate that they meet the requirements. The two most important requirements are funding source and governing body. Public charities provide higher tax benefits for their donors, but are subject to stricter qualifications than private foundations.
Funding Source and Spending
Public charities get most of their financial support from the public via fundraising: soliciting donations or grants from individuals, the government, corporations, and private foundations. To maintain tax-exempt status, a public charity must verify to the IRS that they receive a substantial portion (33.33% or more) of their support from the general public.
Public charities spend their money to conduct charitable activities and/or provide services. They rarely make grants (although they can).
Public charities must have a diverse board of directors, and no more than 49% of the board can be made up of “interested directors.” Interested directors are anyone who has been compensated by the corporation for their services in the last 12 months or any member of that person’s family. The majority of the board also cannot be related by blood or marriage.
Public charities are required to file Form 990, which is similar to form 990-PF but requires less information. Public charities must report their assets, total figures for donations and grants received (but not the names, addresses, or amounts of contributors), board and top staff members, and whether the charity makes grants.
So, Which One do I Pick? There are pros and cons to each classification, and the determination of which one makes the most sense for your nonprofit will depend on your corporate structure, your mission, and your fundraising goals. If you are interested in learning more about starting a nonprofit corporation, or submitting a 501(c)(3) application for an existing nonprofit, please reach out to us at firstname.lastname@example.org or (415) 633-6841.
Disclaimer: This article discusses general legal issues and developments. Such materials are for informational purposes only and may not reflect the most current law in your jurisdiction. These informational materials are not intended, and should not be taken, as legal advice on any particular set of facts or circumstances. No reader should act or refrain from acting on the basis of any information presented herein without seeking the advice of counsel in the relevant jurisdiction. Bend Law Group, PC expressly disclaims all liability in respect of any actions taken or not taken based on any contents of this article.Read Less