Private Foundations and Public Charities

The Internal Revenue Service (IRS) has allowed for the creation of tax-exempt charitable organizations through the granting of 501(c)(3) status. These groups manifest in one of two ways: as private foundations or public charities.

To qualify for tax-exempt charitable status, both private foundations and public charities must exist for one of the following purposes as stated by the IRS: “charitable, religious, educational, scientific, literary, testing for public safety, fostering national or international amateur sports competition, and preventing cruelty to children or animals.”

The IRS goes on to define “charitable” purposes as “relief of the poor, the distressed, or the underprivileged; advancement of religion; advancement of education or science; erecting or maintaining public buildings, monuments, or works; lessening the burdens of government; lessening neighborhood tensions; eliminating prejudice and discrimination; defending human and civil rights secured by law; and combating community deterioration and juvenile delinquency.”

What Is a Private Foundation?

A private foundation is a nonprofit charitable entity that is generally created by a single benefactor, usually an individual or a business. Using this initial seed donation, known as an endowment, an investment is made to generate income, which is then dispersed in the form of grants to individuals or other charities in accordance with the foundation’s charitable purpose.2

Many investment products are able to offer a stable and consistent rate of return (think of your own savings account). Therefore, the endowment structure of private foundations provides a consistent, stable, and reliable source of continuing funds. This is important, as budgeting and funding decisions can be made with greater confidence. This has the effect of ensuring timely and efficient access to the aid that the foundation seeks to provide.

A chief benefit of operating a foundation comes from the degree of control available. The person responsible for running the foundation can decide whom or what to support and make the investment decisions. The organization’s board of directors can consist entirely of the members of a single family.

However, a chief criticism of private foundations stems from that operational independence. Their private funding source allows them to ignore public opinion and possibly support socially contentious projects. In addition, they may generate less-than-optimal outcomes by focusing their efforts incorrectly. Private foundations also have more mandatory paperwork (to ensure the appropriate use of funds) as well as minimum asset distribution requirements (5% each year).

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