Information regarding Private Foundations and Public Charities is provided in the following sub-sections:
- Choosing to implement a Private or Public Non-Profit Organization
- Typical Uses
- Tax Compliance
Tax exempt organizations fall into two broad categories, Private Foundations and Public Charities. In either case, a tax exempt organization is a permanent fund established and maintained by contributions for charitable, educational, religious, research, or other benevolent purposes. See the list of Approved Charitable Organizations.
Every organization that qualifies for tax exemption as an organization described in section 501(c)(3) of the Internal Revenue Code is a private foundation unless it falls into one of the categories specifically excluding it from the definition of private foundation. In general, purposes having humanitarian and/or charitable causes may qualify your organization as tax exempt under the Internal Revenue Code.
In order to choose the type of charitable organization that best suits your specific circumstances you need to understand how your organization intends to operate on a day-to-day basis, where your financial support is derived and how you intend to provide funding or services to other non-profit organizations and the public.
A private foundation is a non-profit entity that is controlled by and receives most of its funding from a single individual, family or business. It is organized exclusively for charitable, educational, religious, scientific and literary purposes under Section 501(c)(3) of the Internal Revenue Code.
Public charities are generally, a large class of organizations excluded under IRC 509(a)(1) and all organizations excluded under IRC 509(a)(2) depend upon a support test. A support test is used to assure a minimum percentage of broad-based public support in the organization's total support pattern.
Public charity qualifying tests:
- One-Third Support Test — An organization will qualify as public supported if it typically receives at least one-third (33.3%) of its total support from sources qualifying as public support.
- Facts and Circumstances Test — If your organization receives more than 10 percent, but less than 33-1/3 percent, of its support from the general public or a governmental unit, your organization may attempt to qualify as a public charity if it can establish that, under all the facts and circumstances, it normally receives a substantial part of its support from governmental units or the general public. To establish this support, your organization should provide on Part IV of the Schedule A, a description of the facts and circumstances which establish that your organization is in the nature of an organization that is publicly supported. Regulations section 1.170A-9T(f)(3) discusses pertinent facts and circumstances. See the regulations at the following website: Code of Federal Regulations section 1.170A-9T(f)(3)
ONE-THIRD SUPPORT TEST
An organization is considered as typically meeting the One-Third Support Test for its current tax year and the next tax year if the organization met the One-Third Support Test on a cumulative basis for the previous 4 tax years before the current tax year. For new organizations, there is a special computation period.
Support for charities includes the following:
- Gifts, grants, contributions or membership fees
- Net income from unrelated business activities, whether or not those activities are carried on regularly as a trade or business
- Gross investment income
- Tax revenues levied for the benefit of an organization and either paid to or spent on behalf of the organization
- The value of services and facilities furnished by a governmental unit to an organization without charge (except services or facilities generally furnished to the public without charge)
Public Support for charities includes the following:
- Direct or indirect contributions from the general public, including contributions from individuals, Trusts or Corporations. However, only to the extent that the total contributions from such individuals, Trust or Corporations, during the 4-year period immediately before the current tax year (or substituted computation period) are not more than 2% of the public charity's total support for the period
- Support received from governmental units
- Contributions from other publicly-supported charities
FACTS AND CIRCUMSTANCES TEST
If an organization fails to meet the One-Third Support Test, it may still be treated as a publicly-supported organization if it typically receives a substantial part of its support from direct or indirect contributions from the general public, governmental units or a combination thereof.
An organization typically meets the requirements of the Facts and Circumstances Test for its current year and the next tax year if, for the 4 previous tax years before the current tax year, the organization meets the Ten-Percent-of-Support Requirement and the Attraction of Public Support Requirement on an cumulative basis and satisfies a sufficient combination of the Public Support Factors. For new organizations, there is a special computation period.
PUBLIC SUPPORT CONSIDERATIONS
- Percentage of financial Support — the greater the public support/total support ratio, the smaller the difficulty of ascertaining the organization's publicly supported character through other factors. If the ratio is low because the organization receives a high percentage of its total support from investment income on its endowment funds, the organization is regarded as complying with this factor if the endowment fund was originally contributed by a governmental unit or by the general public. However, if the endowment funds were originally contributed by a few individuals or members of their families, this increases the organization's burden of establishing compliance. Information regarding the years before the four tax years immediately before the current tax year may also be considered.
- Sources of support — whether an organization receives its public support from governmental units or directly or indirectly from a representative number of persons or it receives almost all of its support from the members of a single family, is used when determining public support. In determining what is a representative number of persons, consideration is given to the type of organization involved, the length of existence, and whether it constrains its activities to a particular community, region or special field that can be expected to appeal to a limited number of persons. Information regarding the years before the measuring period may also be considered.
- Representative control — When an organization has board members which are representative of the public interests they are formed to serve rather than the personal or private interests of a limited number of donors is considered in determining the character of the organization's public supported. An organization meets this requirement if it has board members composed of:
- Public officials acting in their public capacity
- Individuals selected by public officials acting in their public capacities
- Persons having special knowledge or expertise in the particular field or discipline in which the organization is operating
- Community leaders, such as elected or appointed officials, members of the clergy, educators, civil leaders, or other such persons representing a broad cross-section of the views and interests of the community.
Availability of public facilities or services
- — When an organization generally provides facilities or services directly for the general public's benefit on a continuing basis is evidence that the organization is publicly supported.
- A museum or library that is open to the public
- A symphony orchestra that gives public performances
- A conservation organization that provides educational services to the public through the distribution of educational materials
- An old-age home that provides domiciliary or nursing services for members of the general public. The following considerations also provide evidence of public support:
- Participation or sponsoring of the organization's programs by members of the public having special knowledge or expertise, public officials, or civil or community leaders
- Maintaining a program to accomplish its charitable work in the community, such as slum clearance or developing employment opportunities
- Receiving a significant part of its funds from a public charity or governmental agency to wherein it is held accountable as a condition of the grant, contract or contribution.
Membership organization considerations
- Whether the solicitation for dues-paying members is designed to enroll a substantial number of persons in the community or area, or in a particular profession or field of special interest
- Whether membership dues for individual (rather than institutional) members have been fixed at rates designed to make membership available to a broad cross section of the interested public, rather than to financially restrict membership
- Whether the organization's activities are likely to appeal to persons having some broad common interest or purpose
CHOOSING TO IMPLEMENT A PRIVATE OR PUBLIC NON-PROFIT ORGANIZATION
Private foundations are required to distribute at least 5% of the previous year's average net assets for charitable purposes. This amount can include certain administrative expenses incurred by the foundation.
Foundations can conduct their charitable program as long as its program meets the non-profit charitable requirements. A foundation may directly conduct its own program and treat its related expenses such as, supplies, salary and rent. This arrangement is effectively the same as a grant to a public charity.
Self-dealing is situation where a position within a foundation is used for personal gain. People within a Foundation are considered "disqualified persons" and cannot transact with the foundation other than to make donations to it, or under limited circumstances, receive fair market value compensation for personal services.
Contributions to a private foundation may be used for charitable purposes and certain administrative expenses. Allowed distributions from the foundation include grants to public charities, administrative expenses and equipment used to accomplish the foundation's charitable purpose, direct charitable activities and program-related investments. Investment management fees, custodial fees and salaries or board meeting expenses to oversee investments do not count toward the foundation's minimum distribution requirement.
TAX DEDUCTIONS FOR DONATIONS TO THE PRIVATE FOUNDATION
Typically, donations to a private foundation are tax deductible up to 30% of adjusted gross income for cash, and up to 20% for appreciated securities, with a five-year carry forward. Other types of assets, including real estate, can be donated to the foundation, but are subject to limitations. To avoid self-dealing penalties, ensure that property is not donated to the foundation by a disqualified person.
GRANTS FROM THE PRIVATE FOUNDATION
Private foundations typically perform their philanthropy by making grants to recognized public charities. This includes religious, educational, scientific and cultural institutions; poverty relief agencies; or any other organization qualifying as a 501(c)(3) charity. Federal, state and local governments are treated as the equivalent of a public charity if the donated funds are used strictly for charitable purposes. Private foundations also can provide scholarships and make grants directly to individuals for hardship, emergency assistance and medical distress providing they meet certain criteria
Examples of self-dealing include:
- Purchasing items or selling items to the foundation
- Personal use of foundation assets or income
- Borrowing money from the foundation
- Keeping foundation assets on private premises
- Leasing space to or from the foundation for rent
- Using foundation assets to honor a personal pledge of a disqualified person
Disqualified persons include:
- A foundation's officers, directors, trustees, and substantial contributors
- Individuals who own a significant stake in a company that is a substantial contributor. The family members of these individuals
- Certain businesses partially or wholly owned by these individuals
- Family members include a disqualified person's spouse, ancestors, such as parents and grandparents, lineal descendants including children, grandchildren and their spouses.
An organization must be organized and operated in a manner to attract new and additional public or governmental support on a continuous basis. In most cases public charities have a fund-raising committee that structures the internal and external efforts to solicit donations for the organization.
An organization meets this requirement if it maintains a continuous and bona fide program for solicitation of funds from the general public, community, or membership group involved, or if it carries on activities designed to attract support from governmental units or other charitable organizations described in IRC 509(a)(1).
In determining whether an organization maintains a continuous and bona fide program for solicitation of funds from the general public or community, consideration will be given to whether the scope of its fund-raising activities is reasonable in light of its charitable activities. Consideration also will be given to the fact that an organization may, in its early years of existence, limit the scope of its solicitation to persons who would be most likely to provide seed money sufficient to enable it to begin its charitable activities and expand its solicitation program.
A private foundation establishes a legacy of giving and humanitarian care that can carry the family name and supports causes important to you. This structure promotes charitable activities into the future.
Private foundations provide the greatest control of any planned philanthropic mechanism. You decide which charities are supported and how the assets are invested. There is a wide array of the types of assets you can donate to the foundation.
A private foundation enables you to involve your family in humanitarian work and to pass core values on to future generations.
Current tax deduction for future grants
You can take an immediate tax deduction for contributed assets, even if the foundation does not make charitable grants until a later date. You are also able to remove taxable assets from your estate, without incurring capital gains taxes.
Flexible Grant Making
You maintain full granting control for the foundation decisions made. You have greater flexibility on the types of grant making by the foundation, which includes grants to individuals, scholarships and international grant making.
Public charities are exempt from paying state and federal income taxes on most activities associated with the Charity's mission.
Public charities are structured to solicit for funds to support the humanitarian purposes that they publicly support. Fund-raising from public and private sources is a core requirement and provides a tax deduction to persons and businesses donating to the charity.
Personal liability protection
As a function of the formation of the entity which contains the charity operation officers, board members and trustees are provided indemnification to provide them with personal liability protection. As such, these officers usually cannot be held personally liable as long as they are acting lawfully.
Principals can receive salaries
By providing necessary services to the charity officers can receive usual and customary salaries based upon the work they provide to the charity.
The tax compliance issues for Private Foundations and Public Charities are very similar and in general are provided in part in the sections below. However, the intricacies of the issues are very complex and advice from an experienced charitable organization CPA and/or legal counsel should be obtained to ensure your charity's regulatory compliance.
You can find additional tax compliance information on the IRS Charitable Organizations website at: http://www.irs.gov/charities/charitable/index.html
Public Inspection of Determination Letter and Application for Exemption
Internal Revenue Code Section 6104(d) requires charitable entities to retain a copy of its tax-exempt determination letter, Form 1023, with all attachments, and any related correspondence with the IRS in its permanent records. The charity must make the foregoing documents available for inspection at its principal office for anyone requesting to view the documents.
Public charities must keep detailed records of each contribution and payment it receives, as well as all other income, to ensure it has the information required to demonstrate its publicly supported organization status.
Tax Return Filings
Public charities must file IRS Form 990 or 990-EZ, including Schedule A, for each year in which its average annual gross receipts are at least $25,000. The average annual gross receipts are calculated on the basis of a three-year rolling average, taking into account the current year and the two preceding years.
Form 990-EZ may be filed for any year in which the charity's gross receipts are less than $100,000 and its total assets at the end of the year are less than $250,000. Otherwise, the organization must file Form 990. If a public charity is in its start-up year, it must file Form 990 or 990-EZ only if its gross receipts in its initial year are at least $37,500. For the second year, it must file Form 990 or 990-EZ only if its average annual gross receipts (for the first two years) are at least $30,000.
For any year in which a public charity is not required to file Form 990 or 990-EZ, it must file the Form 990-N, which is an electronic notice. Regardless of which tax return it is required to file, it must be filed by May 15th of each year. An extension of time to file may be requested by filing Form 2758 no later than May 15th.
Each return filed by a public charity must be made available for public inspection for three years after the filing date under the same terms as the determination letter and application for exemption. Each Form 990 or 990-EZ subject to public inspection is also subject to the requirement that copies be provided when requested.
Receipts for Contributions
The internal revenue code contains several substantiation requirements with respect to providing receipts for charitable contributions. The most common of these apply to gifts of at least $250, and to "quid pro quo contributions" of at least $75. Additional requirements apply with respect to non-cash gifts of property whose value is at least $500.
Most states automatically grant state income tax exemption upon receipt of federal tax-exempt status from the IRS. However, most states require charities to file additional forms to receive state sales tax, use tax, and property tax exemptions. These exemption requirements vary from state to state and must be verified for your state of operation.
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