Starting and Managing a Nonprofit Organization: A Legal Guide

By Bruce R. Hopkins | Go to book overview

CHAPTER SEVEN
Charities: Public or Private?
One of the great myths about tax-exempt organizations is that they are not taxable. (See Chapter 3, Myth 5.) The truth is, they can be taxable. In some situations, they may be subject to heavy taxation. Moreover, the individuals involved—founders, officers, or directors—can also be taxable. Of all types of tax-exempt organizations, the degree of potential taxation is most stringent for private foundations.
WHAT IS A PRIVATE FOUNDATION?
The term private foundation, used generically in the nonprofit organization community for decades, was not defined in the Internal Revenue Code until 1969. At that time, Congress was on an antifoundation rampage, legislating against foundations in every way it could think of. Congress wanted to be certain that each charitable organization that was not clearly public (as explained subsequently) would be treated as a private foundation; it wanted that term to be as all-encompassing as possible. Indeed, in its search for a way to cast a superwide net, it could not write a definition of the term private foundation. Instead, it wrote a definition of what a private foundation is not.Under the federal tax law, every charitable organization—every church, university, hospital, or local community group—is presumed to be a private foundation. Each charitable organization must either rebut that presumption (and become public) or exist as a private foundation.Despite the intricacies of the tax law, the concept of a private foundation is simple. The typical private foundation has four fundamental characteristics:
1. It is a charitable organization and thus subject to the rules applicable to charities generally.
2. Its financial support came from one source, usually an individual, family, or company.
3. Its annual expenditures are funded out of earnings from investment assets, rather than from an ongoing flow of contributions (in this way, a private foundation is much the same as an endowment fund).
4. It makes grants to other organizations for charitable purposes, rather than operate its own programs.

A hybrid entity called a private operating foundation (a blend of a private foundation and a public charity) conducts its own programs but has most of the other features of a private foundation (see discussion following).

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