When starting a nonprofit, it's essential to understand the two primary classifications under the IRS code: public charities and private foundations. These designations affect how your organization operates, raises funds, and complies with IRS regulations. Here’s a breakdown of the key differences.
Public Charity
Public charities are organizations that typically receive a significant portion of their funding from the general public, government grants, or other public sources. They are actively engaged in programs that support their mission, whether that’s through direct services, advocacy, education, or community outreach. Most nonprofits, such as food banks, churches, schools, and medical research organizations, fall into this category.
Characteristics:
Funding Sources: Public charities depend heavily on donations from individuals, businesses, government grants, and other public sources. To maintain public charity status, they must meet the IRS’s “public support test,” which requires them to receive at least one-third of their income from the public.
Operational Focus: These organizations are typically involved in direct service programs, and their activities align closely with their mission. They engage in activities such as running programs, holding events, or conducting research.
Donor Incentives: Contributions to public charities generally come with more favorable tax benefits for donors. For example, individuals can deduct up to 60% of their adjusted gross income (AGI) when donating to a public charity.
Examples: Schools, churches, hospitals, and food banks.
Private Foundation
A private foundation is typically funded by an individual, family, or corporation and is usually managed by a small group of people. Private foundations often focus on grantmaking rather than operating direct service programs. This means they primarily distribute funds to other charitable organizations rather than conducting charitable activities themselves.
Characteristics:
Funding Sources: Private foundations are often funded by one primary source, such as an individual, family, or corporation. They do not rely on the public for the majority of their funding.
Grantmaking Focus: Private foundations often exist to make grants to public charities or other nonprofit organizations. While they can engage in their charitable programs, many focus on philanthropy by giving to others.
Donor Incentives: Donors to private foundations can deduct up to 30% of their AGI, a lower percentage than donations to public charities. This is because the IRS imposes stricter rules on private foundations, especially around how funds are used.
Examples: The Bill and Melinda Gates Foundation, Ford Foundation, or smaller family foundations.
Key Differences
Source of Funding:
Public Charity: Must have a broad base of support from the public or government.
Private Foundation: Typically funded by one source, like a family or corporation.
Operational Model:
Public Charity: Actively engages in direct charitable activities.
Private Foundation: Primarily focuses on making grants to other nonprofits.
Tax Deductions for Donors:
Public Charity: Higher limits for individual deductions (up to 60% of AGI).
Private Foundation: Lower deduction limits (up to 30% of AGI).
Regulations:
Public Charity: Subject to the public support test and must prove ongoing public funding.
Private Foundation: Subject to more stringent rules, including a mandatory 5% distribution of assets each year to avoid penalties.
Which One is Right for Your Nonprofit?
Choosing between a public charity and a private foundation depends on your funding sources, mission, and how you intend to operate. If you plan to engage in direct services and receive support from a broad group of donors, a public charity designation is likely the best fit. However, if you’re looking to fund other nonprofits through grants and have a single source of funding, a private foundation may be more suitable.
Conclusion
Understanding whether your nonprofit is a public charity or private foundation is crucial for its compliance and operations. Both structures have advantages, but they also come with different requirements and restrictions. Consult with your Instant Nonprofit Success Team to determine the best classification for your organization.