Updated: Nov 5, 2019
When you hear the term “charity,” what comes to mind? Goodwill? The Ford Foundation? People for the Ethical Treatment of Animals (PETA)? Your local Church?
According to the IRS, all of these organizations qualify as charities. Charities are legally organized as corporations (or community trusts) that receive tax-exemption under IRS Code 501(c)(3). To qualify for tax-exemption, these organizations must operate exclusively for
religious, charitable, scientific, testing for public safety, literary, or
educational purposes, or
to foster national or international amateur sports competition (but only if no part of its activities involve the provision of athletic facilities or equipment), or
for the prevention of cruelty to children or animals.
Although all charities are required to meet the above criteria, not all charities are classified as "public." Charities can qualify as public charities or private foundations.
Donations to public charities are tax-deductible at a higher percentage than private foundations. In 2019, cash donations to public charities are deductible on 60% of adjusted gross income (AGI), while cash donations to private foundations are generally deductible on only 30% of AGI.
So, if your 2019 AGI is $100,000 and you qualify to itemize your deductions,
up to $60,000 of your cash donations to a public charity are tax deductible, and
up to $30,000 of your donations to a private foundation are deductible.
Public charities also receive donations from the general public. The general public includes individual contributors, corporate donors, grant making foundations, government agencies, charitable remainder trusts, estate bequests, and other sources of public support. In fact, most public charities have to meet an annual public support test that requires them to receive 33 ⅓% of their support from the general public. This public support test has strict rules to prevent a single donor’s control of the organization. For instance, if any donor (other than a government or another public charity) donates an excessive amount, their contribution is excluded from the public support test.
There are two public support tests for public charities: One for organizations described in sections 509(a)(1) and 170(b)(1)(A)(vi) of the Internal Revenue Code, and one for organizations described in section 509(a)(2). Both tests measure public support over a five-year period.
Public charities are also annually required to file a Form 990, Return of Organization Exempt from Tax. This is an extensive form that requires the organization to disclose governance policies, revenue, a statement of functional expenses, compensation, a list of contributors and much more information. This form is required to be made available to the public. In fact, you can find the Form 990 for any public charity on GuideStar.
Public charities with gross receipts and assets below a specific threshold can qualify to file a more simplified version of the Form 990.
In addition to the federal filing requirement, most states have an annual filing requirement as well. If a public charity solicits funds in any state, it will usually have to file some type of annual report with that state.
Public charities are excluded from the laws subject to private foundations under IRS code section 509(a). Different from public charities, private foundations receive income from fewer sources and are usually governed by fewer individuals. Often, family members serve on a Board of Directors and fund the private foundation to carry out the family’s philanthropic legacy.
Most private foundations are required to annually distribute 5% of the net value of non-charitable use assets. This requirement was put into place to prevent foundations from indefinitely holding investment assets. These distributions must be made to qualifying organizations for which the private foundation must exercise expenditure responsibility. If the 5% distribution minimum is not made, the private foundation will be subject to tax on the undistributed amount.
Private operating foundations, foundations that use most of their income on the active conduct of a charitable program, are not subject to the 5% distribution requirement. Instead, they must meet several other tests to maintain their private foundation operating status. Examples of private operating foundations include the Stark Foundation and the Frye Art Museum.
Most private foundations are subject to an excise tax on net investment income under Internal Revenue Code section 4940. Net investment income includes interest and dividend income, capital gains, partnership income, and other types of investment income. Investment fees and other related investment expenses can be deducted from gross investment income to derive total net investment income. The excise tax rate on net investment income is 2%, unless the organization meets a special distribution test (see Form 990-PF, Part V) for which it can qualify for a 1% tax rate. This tax is calculated and reported annually on Form 990-PF, Return of Private Foundation.
Private foundations are also subject to strict self-dealing rules. Self-dealing is the exchange of assets between the private foundation and a foundation officer, director, or other inside person. The following transactions are generally considered acts of self-dealing between a private foundation and a disqualified person:
In addition, the law prohibits indirect self-dealing. Thus, transactions between organizations controlled by a private foundation may also be taxable self-dealing. The penalty for self-dealing is a tax equal to “10 percent of the amount involved with respect to the act of self-dealing for each year (or part thereof) in the taxable period.”
Finally, private foundations cannot engage in lobbying activities. They are, however, allowed to make grants to organizations that lobby. This is different from public charities that can engage in limited lobbying activities under subsection (h) of IRS code section 501.
As you can see, public charities and private foundations have a myriad of differences. Knowing the difference between the two is key to tax and planned giving strategies. If you have additional questions on public charities, please contact The Little CPA.
This material has been prepared for informational purposes only, and is not intended to provide, and should not be relied on for, tax, legal or accounting advice. You should consult your own tax, legal and accounting advisers before engaging in any transaction.