The previous post in this series examined types of non-profit entities, both public benefit and mutual benefit organizations. This post deals more specifically with the types of public benefit organizations, commonly referred to as “501(c)(3)” organizations under the section of the Internal Revenue Code that authorizes their tax exempt status.
There are a large variety of different 501(c)(3) organizations. Educational institutions, churches and organizations that test for public safety are exempt from tax. Organizations with charitable purposes that receive a significant amount of support from the general public or the government are also exempt from tax and are often referred to as “public charities.” The tax law requires that at least one third of the organization’s support each year come from a combination of contributions, gifts, membership fees, grants, admission fees or charges for activities related to the organization’s exempt purpose. These amounts need to come from individuals or entities that are not “disqualified” or from governmental agencies. “Disqualified” individuals include directors, officers, trustees and those who have made contributions in excess of $5,000 that represent more than 2% of total contributions for the year. No more than 1/3 of a public charity’s support can come from investment income or unrelated business activities.
Most 501(c)(3) organizations strive to be treated as public charities if they are not educational, religious or public testing organizations. Public charities receive tax-deductible contributions from their donors, and the deduction limits are among the most generous under the tax law. A future post will discuss those contribution limitations.
If an organization does not receive the broad support of a public charity, it will be treated as a private foundation. Many private foundations are supported by a small number of donors and they may have few operations beyond distributing funds to other charities. There are, however, organizations funded by few individuals who actively undertake charitable activities, called private operating foundations.
Private foundations have become subject to stricter and stricter regulation. There are greater disclosure requirements applicable to foundations than public charities. The Internal Revenue Code imposes a 2% tax on a private foundation’s net investment income (there are circumstances under which this tax can be reduced). To prevent these entities from hoarding funds and ensure that they are performing a charitable purpose, they are generally required to distribute 5% of assets each year. And, while contributions to private foundations are tax-deductible, they are subject to lower limits than public charities. Future posts will more fully discuss the additional requirements on private foundations.