Public charities and private foundations are governed by section 501(c)(3) of the Internal Revenue Code, a code implemented by the Internal Revenue Service (IRS). Unless an organization proves that it is a public charity, it will be considered a private foundation by the IRS. Distinctions between the two are based on their funding source and purpose. Each of these organizations is subject to different tax laws.
Public Charity Defined
Public charities engage in activities to promote general welfare and do not exist to make a profit. A public charity is an organization that 1) obtains financial resources from the government or general public, 2) exists solely to assist an established public charity, or 3) receives income from events it hosts to support its tax-exempt purposes. In general, the organization’s income must derive from a multitude of different sources. Many churches, hospitals and schools are public charities.
Private Foundation Defined
Private foundations also engage in activities that are geared towards enhancing or supporting general welfare, but their funding derives from a single source. Typical sources include a family or corporation. Additionally, most private foundations do not operate charitable events or agencies, but instead provide funding to other organizations to do so. They are, therefore, mainly a financial resource for other charities. Even though private foundations are nonprofit organizations, they are not tax-exempt.
Taxation of Charities and Foundations
To be exempt from taxes, a public charity must inform the IRS that it is not a private foundation within 27 months of its establishment. Tax exemption, however, does not excuse the charity from filing a yearly tax return. If the charity has made even a single payment to one person with influence over the charity, it may have to pay taxes on that payment.
Private foundations are not tax-exempt. These organizations must pay taxes on any earned investment income. Foreign private foundations are subject to these tax laws. Foundations must file a yearly tax return and pay either quarterly or yearly taxes.
Deductible Donations to Charities and Foundations
A member of the general public can donate to either a charity or foundation. Despite being funded by a single source, there is nothing that prevents the foundation from accepting money offered by a third party. Accepting this money does not change the foundation’s status to that of a charity.
The donating individual, however, can deduct donations made only to a public charity from his taxes. The amount of deduction depends on what the donation was and how much it was worth. Donations to private foundations are not tax-deductible.
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