Private Foundation vs Public Charity: The Differences Explained
Charitable organizations support and fund causes and initiatives across the world. In this guide, we’ll explore two types of charitable organizations: private foundations and public charities. Although there are similarities, there are important differences in the ways foundations and charities are set up and how funds are collected.
In this guide, we’ll delve deeper into the question of private foundation vs public charity, discussing charity and foundation differences and providing a private-public foundation comparison.
What Is a Private Foundation?
A private foundation, which may also be known as a private nonprofit, is an independent charitable organization. In most cases, private foundations are established by wealthy individuals, families, or businesses. Unlike public charities, which participate in fundraising activities, private foundations usually generate funds via investment from groups, families, or philanthropists. It’s common for foundations to bear the name of their founding members as part of the organization’s moniker; the Bill and Melinda Gates Foundation is a well-known example of this.
Private foundations are eligible for tax-exempt status in the US provided that they operate within IRS guidelines. To qualify as a 501(c)(3) private foundation, the organization must exist to support one of the causes mentioned in the following IRS guidance: “charitable, religious, educational, scientific, literary, testing for public safety, fostering national or international amateur sports competition, and preventing cruelty to children or animals.”
The most important foundation and 501(c)(3) comparison is tax-deductible status. Donations to all charities, including private and public foundations that qualify as 501(c)(3) entities are tax-deductible to donors.
How Do Private Foundations Work?
Typically, private nonprofit organizations are set up by sole benefactors, families, or companies. In most cases, the foundation uses an endowment (an initial investment) to generate funds, which are then distributed to causes, initiatives, programs, or schemes run by other individuals or charities. The structure of a private foundation contributes to stability and consistency, as the investment products usually generate a steady, reliable income. This makes budgeting simpler and enables boards, panels or individuals to decide where to spend money and how to make funding choices.
As private foundations are run by donors, they maintain control of:
- The foundation’s purpose and funding goals and objectives
- The makeup of the board
- Funding decisions and the disbursement of funds
- Which causes to support
What Are Public Charities?
Public charities are charitable organizations that rely on donations from the general public to support good causes and initiatives. IRS public charities are required to generate at least 33.3% of their income from contributions from the public or meet the criteria set out in the 10% facts and circumstances test. If you operate a public charity, the funds you collect from members of the public are used directly to support your endeavors, for example, giving shelter and meals to homeless people or providing healthcare.
It is critical for boards that run public charities to demonstrate that the acquisition of funds is not carried out to serve the interests of board members or donors. The sole aim must be to support charitable causes through grants and fundraising.
As public charities depend on donations from the general public, they must form a panel of independent members. The board should meet regularly and take responsibility for decision-making. The board should be diverse and it should represent the purpose the organization serves. A public charity board should not include several members of the same family.
Private Foundation vs Public Charity: The Key Differences
The most significant difference between a public charity and a private foundation is the way in which funds are acquired. However, there are several important differences to be aware of. These include:
Funding is the most significant point to address when discussing charity and foundation differences. Private foundations are usually funded by a charity endowment, an investment made by the benefactor or corporation. The funds generated by the endowment are distributed in line with the foundation’s purpose and funding objectives. Public charities are supported by donations from members of the public, which are usually collected through grants, fundraising campaigns, one-off donations, or regular contributions.
Private foundations often make grants, which are distributed to charities or other organizations. Public charities usually rely on donations from members of the public. It is possible for public charitable organizations to make grants, but this is much less common than for private foundations. Private foundations donate money to public charities or causes, while public charities use funds directly to benefit those in need.
Public charities must demonstrate that they receive a level of support from the general public to meet IRS criteria. Private foundations are not prohibited from fundraising and they can accept public donations, but most are entirely self-funded.
A private foundation is typically run by an individual or a board comprising family members or executives from the same corporation. Public charities must have a diverse board that reflects the charity’s mission; they should not have boards made up of family members or multiple individuals from the same businesses or organizations.
A private foundation requires investment and is usually more expensive to establish. All charitable organizations start life as private foundations. Public charities must prove that they generate at least a third of their income from public donations to qualify for IRS exemption.
Running a private foundation is very different from being a board member of a public charity when it comes to control. Individuals and families that operate according to private foundation rules have much greater control than public charity board members. They decide where the money goes and how and when it is spent. Public charities should have a diverse panel of board members and are required to form a quorum to carry out official business.
Public Foundation vs Private Foundation: What Is the Difference?
It’s common to come across the terms public foundation and private foundation when researching or reading about charitable organizations. A private foundation is not the same as a public foundation; the latter is another name for a public charity. Many charities have ‘foundation’ in their name, for example, the Make-A-Wish Foundation. Public foundations are funded by donations from members of the public, businesses, private foundations, and the government. Private foundations are funded by individuals, corporations, or families. They are not reliant on public support and maintain control of all funding decisions.
Types of Private Foundation
There are two types of private foundations: operating and non-operating foundations.
- Non-operating foundations: Non-operating foundations are the most common type of private foundation. These organizations provide grants for public charities. Private foundations can generate funds through fundraising activities, but non-operating foundations are not typically involved in running programs. Non-operating private foundations are required to distribute a minimum of 5% of their net investment annually.
- Operating foundations: Operating foundations are actually involved and engaged in running charitable programs on a continual basis. To ensure that foundations continue to support initiatives in a sustainable manner, they must contribute a sizable portion - around 85% - of net investment assets per year. Operating foundations undertake charitable activities rather than providing grants for public charities. Examples include setting up and running an animal shelter or buying and delivering food supplies, rather than donating to a food bank.
Private Foundation Rules
To operate a private foundation, individuals, groups, and corporations must be aware of private foundation rules and submit the required legal papers for foundations and charities. The rules relate primarily to taxation and include the following:
- Private foundations must distribute around 5% of the previous year’s net investment assets per year.
- They must provide grants to other charitable organizations rather than individuals (although this may be permitted in certain circumstances, for example, supporting an individual through education).
- They have to pay 1-2% excise tax on net investment income.
Public Charity and Nonprofit Comparison
When reading about charitable organizations, it’s understandable to have questions about nonprofit and foundation differences and make public charity and nonprofit comparisons. Nonprofit is an umbrella term that covers a broad spectrum of organizations. Public charities and private foundations are nonprofits, which means that they are run for the benefit of communities or public or social initiatives. Nonprofits are not run to generate profits for donors, owners, or supporters.
What Are the Pros and Cons of Private Foundations?
If you want to support good causes, you may be thinking about setting up a private foundation. Here are some pros and cons to consider:
- Permanence: Private foundations can operate for many years, providing support to recipients on a consistent basis.
- Control: Private foundations enjoy a much greater level of control than public charities. Individuals and families have the ability to decide how to spend their money, when to donate to causes, and how much to distribute in grants.
- Legacy: Many individuals and families decide to establish a private foundation to form a legacy, which can strengthen ties for the future or commemorate those who have passed.
- Tax benefits: Private foundations that meet 501(c)(3) criteria are tax-exempt. Contributors can usually claim donations as deductibles and benefactors can collect donations without paying tax on them.
- Opportunities: As the rules are more lenient for private foundations than public charities, foundations can take advantage of a wider range of opportunities, including donating to individuals, making international grants, offering scholarships, or setting up and running their own charitable schemes.
- Significant setup funds: To establish a private foundation, you need to have a substantial endowment to invest.
- Time commitments: Running a private foundation isn’t for the faint-hearted; it takes up a lot of your time.
- Record keeping and administration requirements: The paperwork demands of establishing and managing a private foundation can be overwhelming.
Private foundations and public charities are both forms of charitable organizations. Private foundations are usually established by individuals, families, or companies, and they make grants and distribute funds through their own investment assets and funds. Public charities rely on donations from the public and they support good causes, communities, and individuals directly.
It’s important to understand the differences between private foundations and public charities if you want to support projects or programs, or if you’re thinking about setting up a foundation. Private foundations retain control of funding decisions, but they’re expensive to set up and they often require a lot of time and effort, particularly during the early stages. Public charities have diverse boards, which are responsible for making decisions, but they are governed by rules that dictate how money is collected and spent.
Nonprofits can be either public or private. Both private and public foundations are examples of nonprofits, as they aren’t run for private interests. Nonprofits do not generate profits for donors, benefactors, or board members.
Yes, a private foundation is considered a charitable organization. Private foundations are usually established by wealthy individuals, families, or corporations as a means of giving back and helping others. In most cases, private foundations distribute funds to public charities.
Technically, a private foundation can donate to another private foundation, but it is much more common for private foundations to provide grants to public charities. There are rules that affect taxation when offering donations to entities that are not classed as public charities.
Private foundations that meet IRS 501(c)(3) criteria are exempt from federal income tax. However, they must pay an excise tax of 1-2%. Under 501(c)(3) guidelines, donors can make a tax-deductible contribution to a private foundation.
There’s no difference between a public foundation and a public charity. However, there are several differences to highlight when discussing a private foundation vs public charity. Public charities collect donations from members of the public, they must have a diverse board, and they usually engage in fundraising activities to generate income to support good causes. Public charities usually support programs directly. Private foundations are established by families, sole benefactors, or companies. They usually make grants, which are distributed to public charities. Boards often include several members of the same family.
Danica’s greatest passion is writing. From small businesses, tech, and digital marketing, to academic folklore analysis, movie reviews, and anthropology — she’s done it all. A literature major with a passion for business, software, and fun new gadgets, she has turned her writing craft into a profitable blogging business. When she’s not writing for SmallBizGenius, Danica enjoys hiking, trying to perfect her burger-making skills, and dreaming about vacations in Greece.
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