We hear the term “non-profit” bandied about a lot in the news and in the community. I believe that most people have a very specific thing in mind when they hear non-profit, but it can actually be used to refer to a few different types of organizations.
There are a few different types of tax-exempt statuses with the IRS.
This post is going to focus on 501(c)(3) organizations. These organizations are NOT created to influence legislation. Sometimes clients ask how they can give back to their local community or an international cause with the assets that they have accumulated through their hard work.
We help these clients create a strategy that builds charitable giving into their estate planning OR their business planning (we’ve started building it into our own business here and we have plans to expand that). It can create positive change in the world and can also be a great way to reduce their tax burden (more on that in later posts).
There are two main categories of 501(c)(3): Public Charities and Private Foundations. The distinction rests on where the organization gets its money from and what it can do with the money.
Public Charities: A Public Charity is mostly supported by or mostly funded by the general public. They have an active fundraising strategy. Exempt activities are defined by the IRS. This is what most people think of when they think of non-profits. Charities are required to have an “exempt purpose” that is carried out using the funds they raise. All donations to Public Charities are tax-exempt.
Most people can, if they want, build a gift to a public charity or to a collection of public charities into their estate plan or business plan. This can reduce your taxable income and create a positive change.
Private Foundation: A Private Foundation is generally supported and/or funded by a single person, family, a small group, or corporation. You can’t just dump money into a charitable trust or non-profit corporation and call it a Private Foundation. Private Foundations can be difficult to maintain on your own because the IRS has a number of requirements for them. One of the more important requirements for Private Foundations is that the foundation has to, at least, distribute 5% of the assets to charitable organizations and causes to maintain its tax-exempt status.
There are really two types of Private Foundations: Operating and Non-Operating. The Non-Operating Private Foundation is far more common. Operating Private Foundations create and operate programs that have a charitable purpose.
Because of the costs associated with creating and maintaining a Private Foundation, they are generally not worthwhile for people, families, or corporations until they can give a more substantial amount.
That said, Private Foundations can be a great way to create a legacy, can create a vehicle for investments, and can reduce taxable income.
Private Foundations give money (grants) to Public Charities, but Public Charities generally do not give money to Private Foundations (particularly not to non-operating Private Foundations). Public Charities can, however, operate like a Private Foundation by making grants to other Charities.
Shreya Ley is a Seattle estate planning attorney. If you have questions, don’t hesitate to ask.