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The staff of a private foundation meets to discuss their upcoming agenda.Not every charitable organization qualifies as a public charity according to government standards. However, a private foundation earns that distinction. A private foundation is a non-governmental, nonprofit organization set up for charitable purposes. Here’s how it works and where it does the most good.

Private Foundation Defined

As mentioned earlier, a private foundation is a nonprofit set up for charitable purposes. Its funding usually comes from an individual, a family or a corporation. A board of directors or trustees manages the foundation and decides how to use its assets for the public good. Mostly, this consists of making grants to other nonprofits.

Both private foundations and public charities are recognized by the Internal Revenue Service as 501(c) 3 organizations. This means they exclusively operate as charitable organizations. Both are tax-exempt and provide opportunities for individuals and corporations to get tax deductions by making contributions.

Private Foundations and Public Charities

The difference between public charities and private foundations is that public charities obtain much or all of their financial support from the public. Private foundations are instead funded by individuals, families or corporations.

There are more than 1  million public charities in the United States, according to the National Center for Charitable Statistics. Examples of leading public charities include the United Way, American Red Cross and American Heart Association.

Private foundations are subject to more regulations than public foundations. The IRS considers any 501(c) 3 charity to be a private foundation unless it shows it is substantially supported by funds received from the public. IRS Form 1023 is usually used for this purpose.

Types of Private Foundations

Approximately 100,000 registered private foundations exist within the United States, according to the National Center for Charitable Statistics. For example, the largest private foundation is the Bill and Melinda Gates Foundation, with approximately $40 billion in assets. Other large private foundations include the Ford Foundation, the Lilly Endowment, the Foundation to Promote Open Society, the Robert Wood Johnson Foundation and the William and Flora Hewlett Foundation.

The nonprofit, grant making and foundation industry informally recognizes three types of private foundations. They differ in governance and in the source and use of the foundations’ funds.

  • Family foundations use a family endowmentfor funding. The family members typically govern the foundations.
  • Independent foundations function autonomously of the benefactor, the benefactor’s family or a corporation. Their funds may come from a family or group of individuals.
  • Corporate foundations receives support from the corporations that create them. These foundations often make grants in fields related to the corporation’s business activities but the foundation is a separate legal entity.

Foundations’ Tax-exempt Status

One of the key features of private foundations is their tax-exempt status. Private foundations pay no federal income tax.

Furthermore, contributions to private foundations, like other charitable contributions, can give individuals and corporations tax deductions. These tax deductions can reduce income taxes, capital gains taxes and estate taxes.

Foundations Serving Public Good

Grants from private foundations often support the work of nonprofit volunteer organizations and initiatives.Because they solely serve the public good, the IRS exempts private foundations from taxes. Foundations typically carry out their mission by making financial grants to other nonprofits. These nonprofits support charitable, religious, educational or similar activities that benefit the public.

Private foundations may also award scholarships to recipients of their choice, provide funds for disaster relief and make international grants. Some private foundations, known as operating foundations, may run their own charitable programs.

Private Foundation Limits

While private foundations pay no income taxes, they do have to pay an excise tax of 1.39% on investment income. Also, there is a limit on tax deductions to individual and corporate contributors. Meanwhile, you can’t deduct more than 30% of adjusted gross income for contributions to private foundations.

The foundation has to file a form with the IRS, Form 990-PF, disclosing all amounts and recipients of grants. And there are restrictions on what they can do.

Private foundations cannot support election campaigns. Restrictions also govern self-dealing between contributors and the foundations. And there are limits on holdings in private businesses.

Private foundations have to distribute at least 5% of their assets every year as grants or to fund charitable operations.

The Bottom Line

Filing taxes as a private foundation may require you to file using a specific tax form.Private foundations are tax-exempt nonprofit organizations that fund activities and organizations promoting the public good. They do this mostly by making grants to other nonprofits. Individuals, families and corporations set them up and support them. However, private foundations also provide opportunities for individuals and corporations to get tax deductions by making contributions.

Private Foundation Tips

  • The term “foundation” has no legal definition. As a result, you can’t assume that an organization that calls itself a foundation is a charity. Even if they aren’t among the 50 worst charities in the country, private foundations deserve scrutiny.
  • Aren’t sure if a private foundation is right for your needs? A financial advisor can help you make that call. Finding the right financial advisor that fits your needs doesn’t have to be hard. SmartAsset’s free tool matches you with financial advisors in your area in 5 minutes. If you’re ready to be matched with local advisors that will help you achieve your financial goals, get started now.

Photo credit: ©iStock.com/monkeybusinessimages, ©iStock.com/SDI Productions, ©iStock.com/Dean R Specker

Mark Henricks Mark Henricks has reported on personal finance, investing, retirement, entrepreneurship and other topics for more than 30 years. His freelance byline has appeared on CNBC.com and in The Wall Street Journal, The New York Times, The Washington Post, Kiplinger’s Personal Finance and other leading publications. Mark has written books including, “Not Just A Living: The Complete Guide to Creating a Business That Gives You A Life.” His favorite reporting is the kind that helps ordinary people increase their personal wealth and life satisfaction. A graduate of the University of Texas journalism program, he lives in Austin, Texas. In his spare time he enjoys reading, volunteering, performing in an acoustic music duo, whitewater kayaking, wilderness backpacking and competing in triathlons.
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