To many, the words tax-exempt are synonymous with churches and synagogues. However, there is much more to these words than meets the eye. In fact, the structural variations of tax-exempt organizations are so numerous that the IRS had to come up with new terms to classify the various organizations. These classifications are not merely labels. They hold significant implications for the organization and donors alike. In this article, we hope to bring some clarity regarding the different types of tax-exempt organizations that are out there.
Private Foundation
A Private foundation is an umbrella term used by the Tax Code to encompass all Section 501(c)(3) organizations not specifically excluded from its definition. The organizations excluded from the definition of private foundation are referred to as A public charities, which will be discussed in further detail below. Private foundations typically receive their funding from one primary source, generally one family or one corporation, and they do not seek donations from the general public. Unlike public charities, private foundations refrain from active participation in charitable activities, such as hosting events or running a charitable organization. Instead, they tend to make grants and gifts to support existing organizations in their charitable endeavors. As a result, private foundations have annual required minimum distribution amounts. Contributions to private foundations are generally deductible by the donor to the extent of 30 percent of his or her adjusted gross income.
Private Operating Foundation
The simplified definition offered by the IRS of a A private operating foundation is a private foundation that devotes most of its resources to the active conduct of its exempt activities. As the name suggests, in order to qualify as a private operating foundation, the organization must actually operate charitable programs. This active participation distinguishes a private operating foundation from a mere private foundation. Unlike private foundations, private operating foundations are not required to make annual minimum distributions. Contributions to private operating foundations were generally deductible by the donor to the extent of 50 percent of his or her adjusted gross income. This limit was temporarily raised to 60 percent by the Tax Cuts and Jobs Act of 2017 for taxable years beginning prior to January 1, 2026. Should Congress do nothing, the limit will revert back to the original 50 percent on January 1, 2026.
Public Charity
As mentioned above, the term public charity encompasses those Section 501(c)(3) organizations that have been specifically excluded from the definition of private foundation. Examples of public charities include churches, temples, educational institutions, hospitals, medical facilities, and government-funded or operated charities. Public charities actively provide charitable services and, typically, receive funding from numerous sources including the public, the government, corporations, private foundations, or even other public charities. Like in the case of private operating foundations, contributions are generally deductible by the donor to the extent of 50 percent (currently 60 percent) of his or her adjusted gross income.
As you can see, the Tax Code can be complex and difficult to understand. If you are looking to set up a tax-exempt organization and are wondering which of these structures is best for you, get in touch with one of our attorneys who will be happy to go over all the options with you.