Within the 501(c)(3) classification, an organization is considered either a public charity or a private foundation. The primary distinction between these classifications is the amount of public involvement in their activities.
Tax-exempt organizations under Internal Revenue Code (“IRC”) Section 501(c)(3) are presumed to be private foundations, a less favored classification from a tax standpoint. In order to be classified as a public charity, the organization must request and qualify for a ruling that it is a public charity. This is done via IRS Form 1023, which an organization uses to request exempt status from the IRS.
Public Charity
A public charity is a nonprofit organization which solicits donations from the public, such as churches, schools, hospitals, medical research organizations, and other publicly-supported organizations. There are four sections of the IRC that allow a nonprofit to be considered a public charity.
Under Section 509(a)(1), a public charity must receive one third or more of its support from public contributions or be a church, school, hospital, government operated organization for the benefit of a university, or an agricultural research organization. This requires a charity to maintain a good reputation and appeal to public sentiment, as well as to frequently solicit donations.
Under Section 509(a)(2), a public charity must receive more than one third of its support from contributions, membership fees, and receipts from activities that advance its exempt functions. Additionally, not more than one third of its support can come from gross investment income.
Under Section 509(a)(3), a public charity must be organized to support public charity or certain other qualified entities. This means the public charity operates for the benefit of another public charity.
Under Section 509(a)(4), a public charity is organized and operated exclusively for testing for public safety. This is a narrow classification and most public charities will not utilize this avenue to public charity status.
It can be beneficial to be classified as a public charity because donors can often deduct a larger percentage of their contributions from their income taxes. There are also fewer operating restrictions and penalties imposed on public charities than private foundations, as long as they continue to qualify for public charity status.
Private Foundation
Private foundations are often run by a family or small group of individuals and may make use of investment income as well as donations to fund its activities. Support for private foundations comes from a smaller number of sources, or often just a single source.
Because private foundations do not need to maintain favor with the general public for their operating income, they tend to be more independent, and less open to public scrutiny. Because of this they must obey certain operating restrictions and are subject to excise taxes if they fail to comply. These include restrictions on self-dealing, an annual income distribution requirement, limits on holdings in private businesses, provisions that investments do not jeopardize operations, and provisions to ensure expenditures meet an exempt purpose.
Further, donors to private foundations may not be able to deduct as much of their contribution as they could if donating to public charity. However, this is offset by the fact that private foundations are not generally soliciting donations from the general public, so the donors tend to be the family or individual running the foundation.
Conclusion
Public charities are charitable organizations which are supported by donations from the general public. In order to qualify as a public charity, an organization must meet certain IRC requirements, described above. Private foundations do not need to solicit public donations and may derive all of their income from a single source. However, because of this lack of public oversight, private foundations are subject to operating restrictions and tax penalties for failure to comply.
Questions? Colorado Nonprofit Legal Center can help! Contact us today.
By Jacqueline Richards