(updated 2025)
What is the difference between a private foundation and a public charity? Many people are not aware that Section 501(c)(3) organizations are divided into these two categories for tax purposes.
One important thing to know is that private foundations usually get money from one source, like a family or business, while public charities get money from many different donors. This difference affects how both types follow tax law and help with their charitable work.
This blog post will make it easy to understand the difference between a private foundation and a public charity. We’ll talk about how each gets money, what rules they have to follow under section 501(c)(3), and why this choice changes everything from the duties of the board of directors to how to fill out tax forms like Form 990-PF or Form 990.
Keep reading if you’re new to running a nonprofit or making changes to one. Answers are coming!
Important Points
Most of the time, private foundations get their money from one source, like a family or a business. Tax Reform Act of 1969 says they have to pay 1.39% tax on investment income and file Form 990-PF every year. The Bill and Melinda Gates Foundation is one example.
Many people and organizations give money to public charities. They have to pass a public support test, which means that at least 33.3% of their money comes from small donors. Instead of Form 990-PF, they file Form 990.
People who give money to public charities can deduct up to 50% of their adjusted gross income (AGI) for cash gifts. For private foundations, the limit is lower: 30% of AGI for cash and 20% of AGI for property.
Private foundations have to follow stricter rules, like not doing business with insiders and giving money to charity every year. To keep their tax-exempt status, public charities need to raise money from a lot of different places.
When you choose between a private foundation and a public charity, it will affect the structure of your board, the costs of compliance, the taxes you pay, and the way you raise money. Ellis Carter, a lawyer for nonprofits, says that you should plan ahead before starting or changing the type of your nonprofit.
Private Foundations
High-net-worth people and families can give to charity through private foundations, which often give out grants. They have to follow the rules set by the IRS and file Form 990-PF every year.
Setting Up and Funding
Most private foundations get their money from one person, a family, or a small group of people. The Bill and Melinda Gates Foundation is a well-known example. It started with big gifts from the Gates family.
Businesses or families may also set up these tax-exempt groups as part of their plans for giving to charity or being socially responsible.
These charities don’t get their money from the general public; they get it from a small number of sources. Instead, they use money from investments like stocks and bonds and gifts from founders to pay for their charitable work.
It was harder for new private foundations to start after the Tax Reform Act of 1969. The number of new foundations that started each year fell from 35% to just 10% after the law went into effect. Most of these nonprofits don’t have to spend time asking for money from many outside donors or holding events to raise money.
Regulatory Framework and Operational Restrictions
After you set up and pay for a private foundation, Congress’s strict rules take effect. For these nonprofits, the Tax Reform Act of 1969 (TRA69) changed everything.
TRA69 made private non-operating foundations file detailed financial reports every year, which they often did on Form 990-PF. These rules make it harder for people to use tax-exempt status to get out of paying federal income tax or estate taxes.
Private foundations can’t do business with insiders, like board members or big donors; if they do, they could face big fines. They also have to give away enough money every year for real charitable work; they can’t just keep it all.
Congress made it illegal for these nonprofits to hold big business stakes and make risky investments in order to keep things fair. Private foundations also have strict rules about how much they can spend; their spending must be clearly related to their stated charitable goals.
You can keep track of grantmakers and other sources of financial help with tools like Google Analytics and Candid. This makes it easier to follow all the rules in your daily work. All of these steps are meant to protect the public interest and make sure that foundation work stays focused on real charity and not personal gain or investments that are too risky.
Tax on Investment Income
The way private foundations must run their businesses also affects their taxes. Private foundations have to pay taxes on their net investment income, which comes from things like dividends, capital gains, and interest.
The excise tax rate is 1.39 percent every year as of 2017.
Private foundations can’t avoid this extra cost like public charities or supporting organizations can. Form 990-PF is the form that a foundation uses to report this tax. Public charities don’t have to pay any excise taxes on the money they make from investments.
This means that most nonprofit organizations that are public charities can keep more money for charitable purposes because they don’t have to pay these special federal taxes on the money they make from investments.
Limits on Donor Deductions
When people give to a private foundation, they can deduct less from their taxes than when they give to a public charity. The limit for cash donations is 30% of your adjusted gross income (AGI).
If you give stocks or real estate instead of cash, it goes down to 20% of AGI. A nonprofit organization that is also a public charity allows donors to claim bigger deductions and helps get more support from wealthy donors.
Some big gifts to private foundations are less likely to happen because of higher compliance costs and rules. Private businesses should also be careful about extra excise taxes if they don’t follow IRS rules about reporting forms like the form 990-pf.
These lower donor limits affect how each charitable foundation raises money, which makes it even more important for public charities to find funding sources.
Public Charities:
Public charities get money from both the government and the general public. Find out what makes them different from private foundations.
Sources of Funding
Most public charities get their money from the government or from regular people. Donations, grants, and fundraising events are all ways to help. Because they rely on a lot of support, churches, schools, and hospitals are considered public charities by law.
Instead of just a few big donors, these nonprofits often run active campaigns to get money from a lot of different sources.
The IRS says that charitable foundations must get most of their money from the public in order to stay tax-exempt. Many groups use Form 1023 to show that they meet these funding requirements.
For instance, disaster relief NGOs and other groups that help people ask for donations from individuals, businesses, and local governments. This wide range of support sets them apart from private foundations, which usually rely on the money of one family or business.
Requirements for Qualification
A nonprofit group must show the IRS that it follows strict rules in order to be considered a public charity. According to federal law, these groups must get at least one-third of their money from the general public or government units.
Many people can give gifts, grants, or donations. Public charities often pass a “public support test” by showing who gives them money every year.
Churches, schools, and hospitals don’t have to take this test because they are special cases and are automatically considered public foundations. If a nonprofit can’t meet the one-third rule, it might still be able to get broad community support by passing a 10 percent “facts and circumstances” test.
To keep their tax-exempt status under Section 501(c)(3), public charities must also file Form 990 with the IRS. People who give money can deduct up to 50% of their adjusted gross income from their taxes.
These rules help make sure that community groups get public support and stay focused on helping others, like with disaster relief or ending poverty.
Why Public Support Tests Are Important
Public support tests help a nonprofit show that it gets money from a lot of people, not just a few big donors. Groups must show that at least 33.3% of their funding comes from donors who each give less than 2% of the group’s total receipts in order to keep their public charity status.
The IRS looks into this every five years. If a group fails this test for two years in a row, it becomes a private foundation and has to file Form 990-PF.
You can’t use gifts from other public charities or government grants for this test. This rule does not apply to new public charities until their sixth year. If they pass the Facts and Circumstances Test, some nonprofits can stay public charities as long as at least 10% of the public supports them.
Keeping good records protects the nonprofit’s tax-exempt status and classification. Nonprofit lawyers and board members, like Ellis Carter, often give advice on how to meet these IRS rules.
Why Classification Is Important
Every part of a nonprofit organization is shaped by correct classification. This step affects IRS paperwork, like which form to file (like Form 990-PF for private foundations) and rules for tax deductions, capital gains taxes, and excise taxes on investment income.
Founders need to make a decision early because it takes five years to switch from a private foundation to a public charity.
This choice also affects how the board of directors is set up. A private foundation usually has a small board, sometimes just family. A public charity, on the other hand, needs a board that is more diverse and includes people from the general public or government agencies.
The source of money is also important; private foundations depend on one main donor or company. Public charities get money from a lot of different people and have to pass strict tests to be tax-exempt.
Getting help from professionals like nonprofit lawyer Ellis Carter can help the group stay within the law and be ready for IRS audits.
In conclusion
Both private foundations and public charities help people in important ways, but they do so in very different ways. Private foundations usually get their money from family or business funds. They have to follow more rules, file Form 990-PF, and pay taxes on the money they make from investments.
Public charities get a lot of money from regular people, have to pass tests to keep their tax-exempt status, and work hard on big charitable projects like disaster relief or education.
Choosing the right structure for your nonprofit organization will help you help more people and keep you safe with taxes. Always talk to experts like Ellis Carter for help. Your next step is important. Take the time to choose the one that will help you reach your goals and make a real difference today!
Questions and Answers
1. What is the main difference between a public charity and a private foundation?
A private foundation gets its money from one person or group, like a family or business. The general public or government units give money to a public charity. Both are types of nonprofits that do good things for others.
2. What are the tax rules for private foundations and public charities that are different?
Form 990-PF must be filed by private foundations, and they may also have to pay capital gains taxes and excise taxes on investment income. Public charities usually have fewer tax obligations and more activities that can be deducted from taxes.
3. Who is in charge of these groups, and how does that affect their work?
Both groups are run by a board of directors, but the board of a private foundation is usually smaller and may include family members or founders. Many people in the community can give their opinions on public charities, so they often have bigger boards.
4. How do the places where they get money affect how they work?
Private foundations get most of their money from endowments or gifts from one main donor. They use the money they make from investments to give grants or do charitable work, like disaster relief or helping organizations like national philanthropic trusts that help the poor. Public charities need a lot of people to keep giving them money so they can stay in touch with what the community needs.
5. Can either group help donors pay less in estate or income taxes?
Yes, giving to either type can lower estate taxes because gifts to these tax-exempt groups are not taxed. Some gifts can also lower income taxes if they meet IRS rules about being a non-profit organization.
Clear classification makes it easier for nonprofits to follow tax laws and IRS rules. Ellis Carter, a lawyer for a nonprofit at Caritas Law Group, P.C., says that careful planning is very important.
She has given advice to a lot of tax-exempt groups in Washington, Arizona, and other places. She works with public charities and private foundations that use Form 990-PF to report the excise taxes they owe on investment income.
Ellis Carter helps boards of directors set up nonprofit organizations like unincorporated associations and supporting organizations. She talks about important compliance issues like donor-advised funds and strict limits on estate taxes.
She can help you with tax breaks, fundraising laws, and government rules across the country if you want to make a big donation or start a charity. You can call Ellis Carter directly at 602-456-0071 or fill out her online contact form to ask questions.