Welcome to a new blog series from TechSoup's general counsel and legal team. We are proud to have a team with a variety of backgrounds and areas of expertise who are able to work across our programs and departments to support the broad range of work we do.
In this series, we hope to shed light on basic concepts in nonprofit law as well as thorny legal issues that arise in the sector. This first installment in the series addresses the fundamental difference between the terms nonprofit, charity, public charity, and private foundation.
Q: Is a nonprofit the same thing as a charity?
A: No. Nonprofits come in many forms and serve multiple functions, from schools, hospitals, and food banks to business leagues, political action committees, and labor unions. All of these entities can be nonprofit, and most of them are eligible for exemption from income tax. However, not all of them are charities.
In the U.S., an organization incorporates at the state level as one of several entity types, such as an LLC, a stock corporation, or a nonprofit corporation. This designation determines the entity's corporate structure. For example, a stock corporation holds shares, whereas a nonprofit corporation does not.
No special recognition is required to identify as a nonprofit. All one has to do is incorporate as that entity type following the directions of the particular state regulator (typically, the applicable secretary of state's office).
A nonprofit corporation will owe taxes on its income unless it applies for tax exemption at the state and federal levels. Otherwise, it is a taxable nonprofit: that is, it does not operate for the purpose of profit and does not distribute profits among shareholders. However, it still owes taxes because it has not sought exemption under a specific section of the Internal Revenue Code.
Tax exemption is available for a number of nonprofit entity types, including those listed above: charities, social welfare organizations, labor unions, agricultural organizations, fraternal societies, social clubs, political action committees, homeowners' associations, civic leagues, trade associations, and others. While these nonprofit entities may qualify for exemption from paying income tax, most are not able to offer donors charitable donation receipts. The privilege of tax-deductible charitable donations is limited to 501(c)(3) organizations and certain other very limited situations.
Q: What is the difference between a 501(c)(3) public charity and a 501(c)(3) private foundation?
A: Public charities are charitable organizations that are supported by a diverse set of donors or constituents and that engage in direct charitable programs. In contrast, private foundations are funded by either one or a limited number of donors — such as a company or family — and typically engage primarily in grantmaking. A 501(c)(3) organization is deemed a private foundation by default unless it can prove to the IRS that it qualifies as a public charity.
The IRS considers public charities to be inherently accountable to the public, whereas it views private foundations as having guaranteed funding, which makes them less dependent on public approval. Accordingly, the IRS imposes an array of regulations and restrictions on private foundations (PDF) to ensure compliance in their operations. Any violations of private foundation rules may result in additional taxes and penalties on the private foundation and its management.
Public charities have the benefit of more flexible rules that govern their operations and more generous tax deduction limits for donors. For example, public charities may give more freely to non-U.S. entities, as long as they are not expending funds for noncharitable purposes. Private foundations, however, must either exercise expenditure responsibility or obtain an equivalency determination before they make a grant to a non-U.S. entity.
Note that just because an organization has "foundation" in its name does not necessarily make it a private foundation. For example, most community foundations are in fact public charities. Many community foundations also act as sponsoring organizations to donor advised funds (DAFs). DAFs are also commonly set up as the charitable affiliate of large financial institutions. Although DAFs qualify as public charities, they are subject to some of the same restrictions on their grants as private foundations because of their unique hybrid nature.
For more detail on the differences between public charities and private foundations, visit our NGOsource program's LegalEASE blog.
This article is for general informational purposes only and does not represent legal advice as to any particular set of facts. Please seek legal counsel as you deem necessary.
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