Introduction to Private Foundations and
Public Charities
Adam Liebling
American Society for the Prevention of
Cruelty to Animals (ASPCA)
adam.liebling@aspca.org
(212) 876-7700 ext 4498
Agenda
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Definitions
Similarities & Distinctions
Types of Foundations
Determining Exempt Status
Expenditure Responsibility
Current Issues & Concerns
Best Practices
The 501(c) Universe
Section of the IRC that lists all nonprofit
organizations exempt from Federal income
taxes
28 different types!
Includes labor unions, fraternal lodges,
teachers’ retirement funds, trade
associations
Some examples: 501(c)(1) – Federal Credit Unions;
501(c)(7) Social & Recreational Clubs; 501(c)(11)
— Teachers' Retirement Fund Associations;
501(c)(13) — Cemetery Companies
501(C)(3)
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 animals.
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:
1.
2.
3.
4.
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 lobbying
Usually has a broad revenue base
Types of Charities
Categories under 501(c)(3):
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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.
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509(a)(2): Exempt purpose activity-supported charities, that is,
charities supported by “program service revenue,” e.g. museums,
nonprofit magazines, etc.
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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:
1.
2.
3.
4.
Organized and operated exclusively for charitable purpose
Initially funded from one source
Its ongoing income is derived from investments
Typically makes grants to other organizations, rather than
operate its own program
Similarities
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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!
Distinctions
Foundations
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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
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Pays no excise taxes
No minimum distribution – charity
can sit on money
Can lobby in limited capacity
Self-dealing acceptable in certain
cases; must be disclosed
Must demonstrate that its income
is derived from a “broad base”
(Public Support Test)
Taxes on Private Foundations
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Because PF’s 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 PC’s.
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2% of net investment income – can be reduced to 1%
if foundation increases its “qualifying distributions” by
a certain amount
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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 on:
Taxes (continued)
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Certain foundation holdings in private businesses;
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:
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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 fundraise.
Easier for public charities to receive $ from private foundations;
difficult for private foundations to receive $ from other private
foundations
More flexibility in their giving and charitable activities
Life Cycles for PFs and PCs
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Must be organized for charitable purpose
Must be incorporated under state or regulatory law
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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 (EIN)
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 Letter)
Apply for other state tax exemptions (sales tax, property tax, etc.)
File annual information returns (Forms 990 & 990-PF)
Alert IRS to material changes or termination
A Note on Political Activity
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"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.”
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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
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Public
Community Foundations
Public Foundations
Donor-Advised Funds
Corporate Foundations
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Private foundation that derives its funds from a for-profit
company
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Focus and grantmaking usually related to the company’s
interests
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Can benefit from other company support, such as shared staff
& departments
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Can be affected by downturns at corporation, layoffs, mergers,
etc.
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Different from corporate-giving programs. Corporate
foundations are separate legal entities whereas corporategiving programs are administered within the corporation.
Family Foundations
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Private foundation in which the
donor or donor’s relatives play a
significant governing role.
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Assets endowed by family wealth
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Generations of family members
are stewards of the philanthropy
and family legacy
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Many private independent
foundations began as family
foundations
Operating Foundations
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Foundation/charity hybrid.
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Like private foundations, does not generally raise funds from the
public
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Like public charities, uses resources for own charitable programs
and services
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Rarely makes grants to other organizations
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Different minimum distribution requirements and excise taxes than
from PF’s
Community Foundations
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An organization that pools assets within a community to service
that community
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Provides a number of consultancy, administrative, and investment
services for donors and local organizations looking to be
philanthropic in their community
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Endowments, scholarships, grant programs, etc., created with
donor intent (but CF retains discretion and control)
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Often operated as a public foundation or a donor-advised fund
(DAF).
Public Foundations
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Simply, a public charity that focuses more on grantmaking than on
providing direct charitable services
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Follows normal IRS rules for public charities, but many adopt
foundation best practices for grantmaking
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ASPCA can be considered a public foundation
Donor-Advised Funds
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A public charity that manages charitable donations on behalf of
another organization, individual, or family.
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Allows donors to be grantmakers without having to set up a private
foundation
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DAFs provide all due diligence and administrative functions, but
retain “control and discretion” of funds – donors can provide
“recommendations” but DAFs have final say
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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
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IRS Determination Letter
Includes a lot of important info (next slide)
Guidestar.org
Notes whether org is 501(c)(3) and Public Charity or Private Foundation
and in good standing
Some grants management systems connect to Guidestar
New tools include better monitoring and alerts
Seal of approval by the IRS
IRS Publication 78
Huge publication (also on IRS.gov as searchable database). Includes most
deductible orgs and their deductible codes
IRS.gov includes revocations, suspensions, additions and deletions
IRS Determination Letter
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Date of letter
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Federal Tax ID/Employer Identification Number (EIN)
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Legal name
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Verifies not a PF and specifies type of charity under 509(a)
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Advance ruling (No longer required as of 2008)
Expenditure Responsibility
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Who can foundations and public charities give grants to?
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What is expenditure responsibility (X-REP/ER)?
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What do foundations have to do to exercise X-REP?
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Alternatives to X-REP
X-REP: Why?
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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.
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Non-Public Charities that PF’s might
make grants to: foreign charities, forprofits, 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:
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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; and
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:
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A pre-grant inquiry
A written grant agreement, signed by an officer, director or trustee of the
grantee, containing the grantee’s 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 foundation.
Alternatives to X-REP
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Using intermediaries/fiscal agents
Must be very careful because of earmarking rules.
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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 advantages.
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Note: If grantee is a for-profit, equivalency
determination not an option
Fiscal Agency/Pass-Through Grantmaking
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Traditionally used to avoid taking X-REP
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Foundation makes grant to an intermediary (usually a nonprofit with
exempt status), who then grants to a non-exempt organization
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The intermediary MUST retain “discretion and control” over money.
Otherwise, it is considered “earmarking.”
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Earmarked grants are as if foundation made grant directly to final
recipient
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No longer considered a viable alternative to X-REP, needlessly
complicates grantmaking
Current Issues & Concerns
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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
Sarbanes-Oxley
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Enacted in 2002 in response to corporate
scandals
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Additional financial disclosure, enhanced
accountability and corporate responsibility,
auditor independence, significantly
harsher penalties for violations
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Does not apply to nonprofits – only
publicly-held organizations
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Many foundations and charities
implemented some Sarbanes-Oxley
provisions
Patriot Act & Related
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Patriot Act – Stiff fines/prison terms for those that willingly fund
terrorism
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Executive Order 13224 – Gov’t 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.
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Embargoes and Sanctions – Foundations cannot violate them
except for very narrowly defined activities.
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So-called “Voluntary Best Practices” – Treasury Dept’s Office of
Foreign Assets Control (OFAC) guidelines for nonprofits on complying
with these issues
Pension Protection Act of 2006
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Largest charitable reforms since the Tax Reform Act of
1969
Affects mainly donor-advised funds and supporting
organizations
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
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Lobbying and ethics scandals  The Legislative and Accountability
Act: new rules for covering expenses of members of Congress
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Frequent talk about raising the minimum distribution percentage
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Frequent talk about executive compensation
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Lower charitable deduction being considered for wealthy donors
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Estate Tax frequently debated
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Independent Sector promotes self-regulation - Panel on the
Nonprofit Sector recommended actions to strengthen governance,
ethical conduct of nonprofits
Recent IRS Activity
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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 electronically
Local Activity
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Greenlining Institute’s 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 philanthropists
Kansas reconsidering exemption from sales tax
Hawaii considering a 1% income tax
Churches may still be exempt
Michigan’s AG had considered enforcing MI-incorporated
foundations to make 50% distributions within MI
Media Scrutiny
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Much coverage of large charities in
the wake of 9/11 and Hurricane
Katrina, focusing on ineffectiveness
and inappropriate handling of funds
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Higher coverage of, and public
exposure to, the nonprofit sector for
reasons positive (Gates/Buffett) and
negative (scandals)
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Blogs/online opinion pieces that
cover the nonprofit sector are
proliferating, but not always
accurate
Public Confidence
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Trust in “institutions” very low
Church scandals
University scandals
Eroding confidence of charities
Historically low approval of Congress
High suspicion of government programs
Greening
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Greening: The active process by which organizations critically
analyze their procedures, policies and practices in order to reduce
their impact on the environment.
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Recycle, Reduce, Reuse
Promoting energy efficiency
Going paperless and telecommuting to reduce carbon imprint
Encouraging public transportation
Addressing food & product safety and sustainability
Leadership in Energy and Environmental Design (LEED) Certification
Many organizations are now (at least) going for the “low-hanging
fruit”
Change
Average staff ages at nonprofits
skewing younger
New technology
The economy
Greening movement
All converging to create dramatic
changes in organizational policies
and procedures
Streamlining becoming valued
over bureaucracy
Other Trends
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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
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For PFs, no self-dealing and avoid appearance of self-dealing.
Okay for public charities in some cases.
No political activity
Conflict of interest, whistleblower policies
Consistent and formalized record keeping and file retention
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:
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Streamlining, doing more with less; creating new policies,
processes, procedures, and technical solutions
Greening; paperless grantmaking
Developing metrics for outcomes, evaluation, and impact
Communicating the organization’s grantmaking successes
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
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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
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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?