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Introduction to Private Foundations and Public Charities


Introduction to Private Foundations and Public Charities Adam Liebling American Society for the Prevention of Cruelty to Animals (ASPCA) – PowerPoint PPT presentation

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Title: Introduction to Private Foundations and Public Charities

Introduction to Private Foundations and Public
  • Adam Liebling
  • American Society for the Prevention of Cruelty to
    Animals (ASPCA)
  • (212) 876-7700 ext 4498

  • Definitions
  • Similarities Distinctions
  • Types of Foundations
  • Determining Exempt Status
  • Expenditure Responsibility
  • Current Issues Concerns
  • Best Practices

The 501(c) Universe
  • 501(c)(3) - Organized and operated exclusively
    for religious, charitable, scientific, testing
    for public safety, literary, or educational
    purposes, or to foster national or international
    amateur sports competition, to promote the arts,
    or for the prevention of cruelty to children or

Public Charity - Definition
  • Public charity is a generic term for all exempt
    organizations described in IRC Section 501(c)(3)
    that is not a private foundation
  • Characteristics
  • Organized and operated exclusively for a
    charitable purpose
  • No part of its activities may involve political
    activities for or against political candidates
  • No substantial part of its activities may involve
  • Usually has a broad revenue base

Types of Charities
  • Categories under 501(c)(3)
  • 509(a)(1) Inherently charitable, The
    Institutions churches, educational
    institutions, hospitals, medical research
    organizations, some governmental units. And
    publicly supported organizations that receive
    substantial support from a governmental unit or
    from the general public.
  • 509(a)(2) Exempt purpose activity-supported
    charities, that is, charities supported by
    program service revenue, e.g. museums,
    nonprofit magazines, etc.
  • 509(a)(3) Supporting organizations Orgs similar
    to private foundations that are connected to, and
    support, a specific (a)1 or (a)2 charity (i.e.
    university printing press)

Private Foundation - Definition
  • Negative definition A private foundation is a
    charitable organization that is not a public
    charity as described under 509(a).
  • Characteristics
  • Organized and operated exclusively for charitable
  • Initially funded from one source
  • Its ongoing income is derived from investments
  • Typically makes grants to other organizations,
    rather than operate its own program

  • Both must be organized and operated exclusively
    for a charitable purpose
  • Both are exempt under IRC Section 501(c)(3)
  • No part of its activities can involve political
    activity (i.e. electioneering/campaigning)
  • Private inurement doctrine cannot engage in
    activities that result in private inurement or
    private benefit. Resources cannot be transferred
    to persons in a private capacity.
  • Both can make grants!

  • Foundations
  • Pays excise taxes (2 of net investment income)
  • Required to make a minimum distribution annually
    (5 of assets)
  • Prohibited from lobbying
  • Must refrain from self-dealing
  • Initially funded by one or few sources relies on
    investment earnings for ongoing support
  • Public Charities
  • Pays no excise taxes
  • No minimum distribution charity can sit on
  • Can lobby in limited capacity
  • Self-dealing acceptable in certain cases must be
  • Must demonstrate that its income is derived from
    a broad base (Public Support Test)

Taxes on Private Foundations
  • Because PFs are privately funded and controlled,
    the IRS feels there is an increased likelihood of
    improper benefits to those controlling the PF.
    Therefore, more rules, restrictions, taxes, and
    penalties than on PCs.
  • 2 of net investment income can be reduced to
    1 if foundation increases its qualifying
    distributions by a certain amount
  • The IRC imposes a two-tier excise tax on private
    foundations, foundation managers, or other
    disqualified persons that engage in certain
    prohibited acts. These are (1) the taxes on
    self-dealing between private foundations and
    their substantial contributors or other
    disqualified persons (2) requirements that the
    foundation annually distribute income for
    charitable purposes and (3) penalty excise taxes
    designed to discourage behavior detracting from a
    foundation's ability to further charitable
    purposes. Thus, the IRS may assess excise taxes

Taxes (continued)
  • Certain foundation holdings in private
  • Foundation investments that jeopardize the
    carrying out of exempt purposes
  • Expenditures for certain activities not
    furthering exempt purposes.
  • Violation of these provisions give rise to taxes
    and penalties against the private foundation and,
    in some cases, its managers, its substantial
    contributors, and certain related persons. The
    first tier (initial) tax is automatically imposed
    if the foundation engages in a prohibited
    act. With the exception of self-dealing acts
    under section 4941, the initial taxes may be set
    aside if it is established that (1) a taxable
    event was due to reasonable cause and not to
    willful neglect, and (2) the event was corrected
    within the correction period.

So, To Sum Up
  • Public Charities Have an Advantage!
  • No excise tax, no minimum distribution
    requirement, more flexibility with lobbying
  • And Also
  • Fewer reporting requirements
  • Higher allowances for donors to contribute (they
    can deduct up to 50 of adjusted gross income vs.
    30 to foundations). Therefore, easier to
  • Easier for public charities to receive from
    private foundations difficult for private
    foundations to receive from other private
  • More flexibility in their giving and charitable

Life Cycles for PFs and PCs
  • Must be organized for charitable purpose
  • Must be incorporated under state or regulatory
  • Protects board from being held personally liable
    in case of lawsuit
  • Charter/Articles of Incorporation primary
    statements regarding purpose/mission and location
    of a corporation must be filed with state or
    regulatory agency
  • Certificate of Incorporation issued by state or
    regulatory agency
  • By-Laws further details on how the corporation
    will be run (powers and voting rights of the
    board meetings quorums etc.). Can be revised.
  • Apply to IRS for Employer Identification Number
  • For PCs, register with state agencies where you
    plan to do fundraising
  • Apply for Recognition of Exemption with IRS,
    receive IRS Determination Letter (aka Exemption
  • Apply for other state tax exemptions (sales tax,
    property tax, etc.)
  • File annual information returns (Forms 990
  • Alert IRS to material changes or termination

A Note on Political Activity
  • "Under the Internal Revenue Code, all section
    501(c)(3) organizations are absolutely prohibited
    from directly or indirectly participating in, or
    intervening in, any political campaign on behalf
    of (or in opposition to) any candidate for
    elective public office. Contributions to
    political campaign funds or public statements of
    position (verbal or written) made on behalf of
    the organization in favor of or in opposition to
    any candidate for public office clearly violate
    the prohibition against political campaign
    activity. Violating this prohibition may result
    in denial or revocation of tax-exempt status and
    the imposition of certain excise taxes.
  • Organizational leaders at 501(c)(3)s should not
    make partisan comments in writing or at official
    or public functions.

Other Types of Foundations/PCs
  • Private
  • Corporate Foundations
  • Family Foundations
  • Operating Foundations
  • Public
  • Community Foundations
  • Public Foundations
  • Donor-Advised Funds

Corporate Foundations
  • Private foundation that derives its funds from a
    for-profit company
  • Focus and grantmaking usually related to the
    companys interests
  • Can benefit from other company support, such as
    shared staff departments
  • Can be affected by downturns at corporation,
    layoffs, mergers, etc.
  • Different from corporate-giving programs.
    Corporate foundations are separate legal entities
    whereas corporate-giving programs are
    administered within the corporation.

Family Foundations
  • Private foundation in which the donor or donors
    relatives play a significant governing role.
  • Assets endowed by family wealth
  • Generations of family members are stewards of the
    philanthropy and family legacy
  • Many private independent foundations began as
    family foundations

Operating Foundations
  • Foundation/charity hybrid.
  • Like private foundations, does not generally
    raise funds from the public
  • Like public charities, uses resources for own
    charitable programs and services
  • Rarely makes grants to other organizations
  • Different minimum distribution requirements and
    excise taxes than from PFs

Community Foundations
  • An organization that pools assets within a
    community to service that community
  • Provides a number of consultancy, administrative,
    and investment services for donors and local
    organizations looking to be philanthropic in
    their community
  • Endowments, scholarships, grant programs, etc.,
    created with donor intent (but CF retains
    discretion and control)
  • Often operated as a public foundation or a
    donor-advised fund (DAF).

Public Foundations
  • Simply, a public charity that focuses more on
    grantmaking than on providing direct charitable
  • Follows normal IRS rules for public charities,
    but many adopt foundation best practices for
  • ASPCA can be considered a public foundation

Donor-Advised Funds
  • A public charity that manages charitable
    donations on behalf of another organization,
    individual, or family.
  • Allows donors to be grantmakers without having to
    set up a private foundation
  • DAFs provide all due diligence and administrative
    functions, but retain control and discretion of
    funds donors can provide recommendations but
    DAFs have final say
  • First DAF was in 1931 (New York Community Trust),
    but DAFs were first legally defined by the
    Pension Protection Act of 2006

Determining Exempt Status
  • IRS Determination Letter
  • Includes a lot of important info (next slide)
  • Notes whether org is 501(c)(3) and Public Charity
    or Private Foundation and in good standing
  • Some grants management systems connect to
  • New tools include better monitoring and alerts
  • Seal of approval by the IRS
  • IRS Publication 78
  • Huge publication (also on as searchable
    database). Includes most deductible orgs and
    their deductible codes
  • includes revocations, suspensions,
    additions and deletions

IRS Determination Letter
  • Date of letter
  • Federal Tax ID/Employer Identification Number
  • Legal name
  • Verifies not a PF and specifies type of charity
    under 509(a)
  • Advance ruling (No longer required as of 2008)

Expenditure Responsibility
  • Who can foundations and public charities give
    grants to?
  • What is expenditure responsibility (X-REP/ER)?
  • What do foundations have to do to exercise X-REP?
  • Alternatives to X-REP

X-REP Why?
  • IRC Section 4945 Grants to organizations that
    are not public charities as described in
    509(a)(1), (2), or (3) are considered taxable
    expenditures and subjected to excise taxes,
    unless Expenditure Responsibility is maintained.
  • Non-Public Charities that PFs might make grants
    to foreign charities, for-profits, other private
    foundations, and public charities that have lost,
    or not yet received, their status

X-REP The Rules
  • Under the Internal Revenue Code, if a section
    501(c)(3) private foundation makes a grant to an
    organization that is not a section 501(c)(3)
    public charity described in sections 509(a)(1),
    (2), or (3) (or, in the case of a foreign
    organization, treated as such), the private
    foundation must exercise expenditure
    responsibility over the grant. To exercise
    expenditure responsibility over a grant, a
    foundation must exert all reasonable efforts
    and establish adequate procedures
  • To see that the grant is spent solely for the
    purpose for which it is made
  • To obtain full and complete records from the
    grantee detailing how the grant funds are spent
  • To make full and detailed reports with respect to
    such expenditures to the IRS.

X-REP Other IRS Requirements
  • In addition, the exercise of expenditure
    responsibility should include the following
  • A pre-grant inquiry
  • A written grant agreement, signed by an officer,
    director or trustee of the grantee, containing
    the grantees agreement to
  • To repay any amount not used for the purposes of
    the grant,
  • To submit full and complete annual reports to the
    grantor foundation on the manner in which the
    funds are spent and the progress made in
    accomplishing the purposes of the grant,
  • To keep records of receipts and expenditures and
    to make its books and records available to the
    grantor at reasonable times, and
  • Not to use any of the funds to influence
    legislation, to influence the outcome of
    elections, to carry on voter registration drives,
    to make grants to individuals or other
    organizations, or to undertake any nonexempt
    activity, when such use of the funds would be a
    taxable expenditure if made directly by the

Alternatives to X-REP
  • Using intermediaries/fiscal agents
  • Must be very careful because of earmarking rules.
  • Equivalency Determination
  • Legal opinion based on affidavits and detailed
    grantee information that grantee can be treated
    as equivalent to a US public charity. Can be
    burdensome and expensive, but there can be
  • Note If grantee is a for-profit, equivalency
    determination not an option

Fiscal Agency/Pass-Through Grantmaking
  • Traditionally used to avoid taking X-REP
  • Foundation makes grant to an intermediary
    (usually a nonprofit with exempt status), who
    then grants to a non-exempt organization
  • The intermediary MUST retain discretion and
    control over money. Otherwise, it is considered
  • Earmarked grants are as if foundation made grant
    directly to final recipient
  • No longer considered a viable alternative to
    X-REP, needlessly complicates grantmaking

Current Issues Concerns
  • Sarbanes-Oxley
  • Patriot Act
  • Pension Protection Act of 2006 (HR4)
  • Other Congressional Activities
  • Recent IRS Activity
  • Local Activity
  • Media Scrutiny
  • Public Confidence
  • Greening
  • Other Trends
  • Best Practices

  • Enacted in 2002 in response to corporate scandals
  • Additional financial disclosure, enhanced
    accountability and corporate responsibility,
    auditor independence, significantly harsher
    penalties for violations
  • Does not apply to nonprofits only publicly-held
  • Many foundations and charities implemented some
    Sarbanes-Oxley provisions

Patriot Act Related
  • Patriot Act Stiff fines/prison terms for those
    that willingly fund terrorism
  • Executive Order 13224 Govt can freeze assets
    of any terrorist or individual or organization
    that supports terrorism. Very vague and broad
    with no requirement that support include
    knowledge or intent.
  • Embargoes and Sanctions Foundations cannot
    violate them except for very narrowly defined
  • So-called Voluntary Best Practices Treasury
    Depts Office of Foreign Assets Control (OFAC)
    guidelines for nonprofits on complying with these

Pension Protection Act of 2006
  • Largest charitable reforms since the Tax Reform
    Act of 1969
  • Affects mainly donor-advised funds and supporting
  • However, burden is on foundations now to ensure
    they take proper actions when funding a 509(a)(3)
    Type III supporting organization.

Other Congressional Activities
  • Lobbying and ethics scandals ? The Legislative
    and Accountability Act new rules for covering
    expenses of members of Congress
  • Frequent talk about raising the minimum
    distribution percentage
  • Frequent talk about executive compensation
  • Lower charitable deduction being considered for
    wealthy donors
  • Estate Tax frequently debated
  • Independent Sector promotes self-regulation -
    Panel on the Nonprofit Sector recommended actions
    to strengthen governance, ethical conduct of

Recent IRS Activity
  • Stronger enforcement scrutiny of exempt
    organizations engaging in political activity
  • Substantial changes to the 990 in 2008
    charities have to now report more about their
    governance and structure
  • Beginning 2007, ALL nonprofits have to file the
    990 or 990-EZ (or 990-N postcard for orgs with
    annual revenue under 25,000)
  • Grace period just ended tens of thousands of
    nonprofits lost their exempt status
  • Soon all nonprofits will have to file

Local Activity
  • Greenlining Institutes push for a Foundation
    Diversity and Transparency Act would have made
    charities and foundations gather data and report
    on the ethnic makeup of their boards and their
    grantees boards
  • NY recently considered exemption of nonprofits
    from property taxes tax on richest
  • Kansas reconsidering exemption from sales tax
  • Hawaii considering a 1 income tax
  • Churches may still be exempt
  • Michigans AG had considered enforcing
    MI-incorporated foundations to make 50
    distributions within MI

Media Scrutiny
  • Much coverage of large charities in the wake of
    9/11 and Hurricane Katrina, focusing on
    ineffectiveness and inappropriate handling of
  • Higher coverage of, and public exposure to, the
    nonprofit sector for reasons positive
    (Gates/Buffett) and negative (scandals)
  • Blogs/online opinion pieces that cover the
    nonprofit sector are proliferating, but not
    always accurate

Public Confidence
  • Trust in institutions very low
  • Church scandals
  • University scandals
  • Eroding confidence of charities
  • Historically low approval of Congress
  • High suspicion of government programs

  • Greening The active process by which
    organizations critically analyze their
    procedures, policies and practices in order to
    reduce their impact on the environment.
  • Recycle, Reduce, Reuse
  • Promoting energy efficiency
  • Going paperless and telecommuting to reduce
    carbon imprint
  • Encouraging public transportation
  • Addressing food product safety and
  • Leadership in Energy and Environmental Design
    (LEED) Certification
  • Many organizations are now (at least) going for
    the low-hanging fruit

Other Trends
  • Online Grantmaking
  • Common Applications
  • Uniform Coding
  • Digital Archiving
  • Data Gathering
  • Emphasis on Outcomes/Metrics/Impact
  • Social Media
  • Endowments/Donations Down, Volunteerism Up
  • Economic downturn

Best Practices for Nonprofits
  • For PFs, no self-dealing and avoid appearance of
    self-dealing. Okay for public charities in some
  • No political activity
  • Conflict of interest, whistleblower policies
  • Consistent and formalized record keeping and file
  • Transparency internally externally
  • Establish an audit committee, if appropriate
  • Environment-conscious/greening policies

The Era of Grants Management
  • Grants Managers are more important than ever!
  • Grants managers are on the forefront of
  • Streamlining, doing more with less creating new
    policies, processes, procedures, and technical
  • Greening paperless grantmaking
  • Developing metrics for outcomes, evaluation, and
  • Communicating the organizations grantmaking
  • Proper due diligence and compliance having the
    right amount of expertise in finance, law, audit,
    and IT. Keeping an eye on changes to the law.

Supporting the Sector
  • Groups
  • Council of Foundations
  • Foundation Center
  • Independent Sector
  • Also
  • Center for Effective Philanthropy
  • Chronicle on Philanthropy
  • Grantmakers for Effective Organizations
  • Philanthropy Roundtable
  • Regional Associations of Grantmakers
    (Philanthropy New York)
  • Emerging Practitioners in Philanthropy
  • Health Research Alliance
  • Grants Managers Network
  • Activities
  • Testifying before Congress
  • Self-defense lobbying
  • Independent studies and recommendations
  • Op-Eds
  • Conferences
  • Education dissemination (news alerts,
    publications, etc.)

Thank you for coming!
  • Any questions?