Private Foundations

Most organizations described in IRC §501(c)(3) are presumed to be private foundations unless they notify the Internal Revenue Service within a specified period of time that they are not. This notification requirement applies to most IRC §501(c)(3) organizations regardless of when they were formed. Even if an organization falls within one of the categories excluded from the definition of private foundation, it will be presumed to be a private foundation, with some exceptions, unless it gives timely notice to the IRS that it is not a private foundation. The only exceptions to this requirement are those organizations that are exempted from the requirement of filing Form 1023, Application for Recognition of Exemption Under Section 501(c)(3).

Definition: IRC §501(c)(3) exempt organizations that are not private foundations:

1) Churches; educational institutions; hospitals and medical research organizations; charitable organizations receiving a major portion of their support from the general public or United States, a state, or a political subdivision; governmental units.

2) Organizations that are broadly supported by the general public (excluding disqualified persons), by governmental units, or by organizations in (1) above.

3) Organizations organized and operated exclusively for benefit of organizations described in (1) or (2) above (a supporting organization).

4) Organizations organized and operated exclusively for testing for public safety.

1) One-Third Support Test: The organization normally must receive more than one-third of its support from gifts, grants, contributions, and membership fees; and gross receipts from admissions, sales of merchandise, performance of services, or the furnishing of facilities that is not an unrelated trade or business.

2) Not More Than One-Third Support Test: Limits the amount of support normally received from the following sources to one-third of the organization’s support for the taxable year:
– Gross investment income, and
– Unrelated business taxable income.

An organization is required to file Form 1023, Application for Recognition of Exemption Under Section 501(c)(3), within 15 months from the end of the month in which it was organized to be treated as tax-exempt. To establish that the organization is a private operating foundation, complete Part III of the exemption application Form 1023. A user fee must accompany Form 1023 along with Form 8718. 
—Private Foundation: An organization that states it is a private foundation when it files an application for recognition of exemption after the 15-month period will be treated as an IRC §501(c)(3) organization and as a private foundation only from the date the application is filed. —Publicly Supported Charity: An organization that states it is a publicly supported charity when it files its application for recognition of exemption after the 15-month period cannot be treated as an IRC §501(c)(3) organization before the date it files such an application. Financial support received before that date may not be used for purposes of determining whether the organization is publicly supported. However, an organization that can reasonably be expected to meet the support requirements can obtain an advance ruling from IRS that it is a publicly supported organization.

The most common type of private foundation is the standard private foundation or "family foundation." It is common for individuals, families, or entities of a family to establish and fund these foundations. Family foundations often fund other charitable organizations, but typically do not carry out any charitable activities themselves. Because of the nature of family foundations, raising funds through solicitations or grants is generally not done. Donors may deduct cash contributions up to 30% of AGI, and may deduct the basis in property donated up to 20% of AGI [IRC §170(b)]. The value of donations disallowed due to AGI limitations may be carried forward for 5 years. 

Private Operating Foundations: Engage in charitable activities. Donations to private operating foundations fall under the more liberal deductibility laws of public charities. 
• Donor may deduct cash contributions up to 50% of AGI. [IRC §170(b)(1)(A)(vii)]
• Donor may deduct full FMV of appreciated property up to 30% of AGI [IRC §170(e)(1)]. See "Contributing Appreciated Stock" below. 

Caution: Donating tangible personal property not related to the exempt purpose of the foundation, limits the donor to a deduction of basis only. Guidelines for a private operating foundation require that it spend at least 85% of the lesser of adjusted net income or minimum investment return directly on the active conduct of its exempt activities (the income test). It must also qualify under one of the following: the asset test, the endowment test, or the support test. Certain private foundations that provide long-term-care facilities are treated as operating foundations only for the purposes of the excise tax on failure to distribute income.

The deduction for the FMV of qualified appreciated stock (including mutual funds) donated to a private foundation has been retroactively extended and made permanent. Generally, donating  capital gain property to a private foundation allows the donor a deduction of basis only [IRC §170(e)(5)(d)]. Limitation: Donations of appreciated stock that exceed 10% of the total outstanding stock of a corporation are limited to a deduction of basis only.

All private foundations are required to file an annual return on Form 990-PF, Return of Private Foundation.

1) Restrictions on self-dealing between private foundations and their substantial contributors and other disqualified persons. 
2) Requirements that the foundation annually distribute income for charitable purposes.
3) Limits in their holdings in private businesses. 
4) Provisions that investments must not jeopardize the carrying out of exempt purposes. 
5) Provisions to assure expenditures further exempt purposes. 

Violations of these provisions give rise to taxes and penalties against the private foundation and, in some cases, its managers, substantial contributors, and certain related persons.

Private foundations are subject to excise taxes on:
• Net investment income.
• Self-Dealing.
• Failure to distribute income.
• Excess business holdings.

Net Investment Income: Section 4940 imposes a 2% excise tax on the net investment income (interest, dividends, rents, royalties, and securities loan payments) of private foundations.

Self Dealing: Section 4941 imposes on the disqualified person (not the foundation) an excise tax equal to 5% of the self-dealing amount, plus an additional 200% tax if the action is not corrected. Managers of the foundation may also be subject to a 2.5% tax if they knowingly allow the self-dealing to take place.

Failure to Distribute Income: Each year, private foundations must distribute 5% of the FMV of the foundation’s net investment assets. Section 4942 imposes a 15% tax on undistributed amounts.

Note: Does not apply to private operating foundations. 

Excess Business Holdings: Combined holdings of a private foundation and its disqualified persons are not permitted to exceed 20% of a corporation’s voting stock, 20% of the profits interest in a partnership, or 20% beneficial interest in other entities.