Definition and Example of Private Foundation
Private foundations are charitable entities supported by a single benefactor or by a small number of sources. It’s common to see private foundations supported by a business, a family, or an individual. The IRS categorizes 501(c)(3) organizations as either public charities or private foundations. These designations are determined based on the level of public involvement in the charitable activities. Public charities typically receive a greater portion of their financial support from either government units or from the general public. On the other hand, private foundations typically receive their financial support from an individual or small group. In some cases, private foundations receive their support from investment income. Private foundations are less open to public scrutiny because of their lack of public involvement, but they are subject to operating restrictions and must excise taxes if they don’t comply with those restrictions.
How Private Foundations Work
There are a few rules from the IRS that private foundations must follow. These include:
Private foundations must file Form 990-PF, Return of Private Foundation each year. Investment income of a private foundation qualifies for an excise tax for most domestic private foundations. Some foreign private foundations may also have to pay a tax on gross investment income if that income is derived from United States sources. There are restrictions on private foundations surrounding how they deal with their substantial contributors and other disqualified people. It’s a requirement that a private foundation annually distributes income toward charitable purposes. There are limits on what a private foundation’s holdings in private businesses can be. Investments can’t harm the carrying out of exempt purposes, and there must be provisions in place to ensure that any expenditures further exempt purposes.
Types of Private Foundations
How a private foundation is funded and governed determines what type of foundation it is. While the following terms aren’t legal classifications, they are commonly used to convey how a private foundation operates:
Independent foundation: An independent foundation receives its support from an endowment that comes from a single source.Family foundation: Usually, a family foundation is funded by an endowment from one family.Corporate foundation: This is a philanthropic organization that is financially supported by a corporation and is a separate legal entity from the corporation financing it.International foundation: This type of private foundation is generally located outside of the United States, and it creates grants in its own country. This type of foundation may also refer to one that engages in cross-border giving.Private operating foundation: This private foundation primarily operates its own charitable programs, but in some cases, it may also make grants.
Private Foundations vs. Public Charities
Let’s look at the differences between these private foundations and public charities as 501(c)(3) organizations. Unlike private foundations, which receive the bulk of their support from an individual or small group, public charities receive support from the public. For that reason, charities are open to public scrutiny. They need to adhere to what the public considers to be appropriate standards. In contrast, private foundations must follow IRS rules and regulations. That said, even though public charities aren’t as heavily regulated as private foundations, they often follow the same rules and regulations as private foundations.
Pros and Cons of Private Foundations
Private foundations differ from public charities, and they have both pros and cons to consider if you are planning to establish your own charitable organization.
Pros Explained
Less public scrutiny: Because funds don’t come from government or public sources, there is less scrutiny surrounding how private foundations operate than there is with public charities.
Cons Explained
IRS rules and regulations: Private foundations must adhere to strict IRS rules and regulations.Fewer sources of funding: Because private foundations are financed by one or very few sources, they can’t fundraise from many different sources like public charities can.
