What are the different types of charitable foundations?
The term “foundation” does not have a universal definition and it oftentimes has a different meaning depending on the situation and context. The most common usage of the term denotes a category of nonprofit organization that typically provides funding and support to other charitable organizations. Below we delve into the structure of charitable foundations and explore their various forms and types.
What is a private foundation?
A private foundation is a 501(c)(3) charitable organization set up to facilitate philanthropic giving. The IRS grants special tax status to a private foundation only if its principal documents clearly show it is dedicated to carrying out a charitable mission and it meets certain federal and state requirements.
Private foundations do not typically have charitable operating programs of their own. Instead, they generally make grants to operating charities such as the American Red Cross. Private foundations do have the prerogative to conduct their own direct charitable programs but this practice is not widespread.
In contrast to public charities, private foundations seldom rely on public funding. Instead, private foundations are most often funded by a private party such as a wealthy family or a successful business enterprise. The private party that provides the funding almost always has control over the foundation. Oftentimes the founder makes a very large contribution at the inception of the foundation that becomes the endowment.
Charitable foundations can be legally structured as either a trust or a corporation, each with distinct governance mechanisms and legal implications. A foundation structured as a trust is governed by a trustee or a board of trustees. This model is based on a legal arrangement in which trustees hold and manage the foundation's assets on behalf of the beneficiaries, in this case, the charitable causes the foundation aims to support. Trust-based foundations are subject to the trust laws of the state in which they are established, which typically require adherence to the specific charitable purposes set out in the trust deed. Conversely, a foundation formed as a corporation is governed by a board of directors and is considered a separate legal entity from its founders. The corporation-based structure is regulated by the state's corporate laws and offers the board a set of bylaws with more formal operational procedures to manage the foundation's affairs. Both structures must ensure that their activities serve the public interest and comply with the Internal Revenue Service's regulations to maintain their tax-exempt status. The choice between a trust and a corporate structure will affect aspects such as the foundation's management, the liability of its managers, and its operational flexibility, which are crucial considerations for the founding parties.
Private foundations offer certain financial advantages to founders, including tax breaks on donations. However, it's widely acknowledged that these advantages are not the primary reasons for setting up a private foundation; rather, the driving force behind establishing a private foundation is often a deep-seated commitment to philanthropy. All private foundations are classified as either operating foundations or non-operating foundations.
What is an operating foundation?
Rather rare in the realm of philanthropy, operating foundations directly manage their own charitable programs instead of providing grants to external charitable organizations. The financial and administrative reins of these foundations often rest in the hands of private benefactors, like a generous family or a thriving business.
This structure is particularly suited for public institutions such as museums, zoos, and libraries, when they are privately funded. Operating foundations enjoy a complete exemption from the excise tax on net investment income (as well as income tax), with the stipulation that they must allocate at least 85% of their investment income to their own charitable initiatives.
What is a non-operating foundation?
Non-operating foundations are the most common type of foundation in society at large. The “non-operating” moniker simply means that the foundation is not set up to operate its own direct charitable programs. Instead, a non-operating foundation’s principal goal is to provide funding to public charities and other philanthropic causes mostly in the form of financial grants. Non-operating foundations can have their own direct charitable projects but they are generally constrained in scope as this type of legal entity is not conducive to operating programs directly. The Gates Foundation, for example, is structured as a non-operating foundation primarily awarding grants but it also conducts a limited amount of direct charitable activities.
Non-operating foundations are the predominant form of private foundations within the philanthropic landscape. Their designation as "non-operating" indicates that they do not primarily manage their own direct charitable programs. Instead, these foundations focus on financially supporting public charities through grants. While non-operating foundations have the prerogative to manage their own direct charitable projects, such ventures are usually limited in scale. For instance, the Gates Foundation, while principally a grant-making entity, does engage in some direct charitable efforts.
Non-operating foundations are not subject to standard federal income tax but are required to pay an excise tax of 1.39% on net investment income. Furthermore, they must distribute approximately 5% of their assets annually towards charitable causes and as grants to public charities. Non-operating foundations encompass a variety of types such as independent, family, and corporate foundations, though these categories lack formal legal definitions.
What is an independent foundation?
Independent foundations stand apart from other private foundations, such as family or corporate foundations, in their governance structure; they are not overseen by the original benefactor, the benefactor's relatives, or a corporate entity. Typically, these foundations are established with endowments from a single source, which can be either an individual philanthropist or a collective of like-minded individuals committed to a common cause. These endowments provide a financial bedrock, allowing the foundation to operate and make charitable contributions without needing ongoing fundraising efforts.
What is a family foundation?
Family foundations, which are a subset of private foundations, are both funded and managed by specific families. At times, these entities are referred to as "private family foundations" to emphasize their non-public funding sources. Governance of these foundations is typically in the hands of the donor's family, who make up the board of directors and thus oversee the foundation's management. While family members may be employed by the foundation, it is more common for them to contribute their time voluntarily, serving without financial remuneration. The leadership and control of these foundations often transition seamlessly from one generation to the next, ensuring continuity of the family's philanthropic legacy without limitation.
What is a corporate foundation?
A corporate foundation is a private foundation that is established, funded, and overseen by a parent corporation. Although closely linked, the corporation and its foundation are separate legal entities. Typically, the foundation's board of directors is composed of executives and employees from the corporation. These foundations are often beneficiaries of annual allocations from the corporation's profits, allowing them to amass significant endowments over time. They tend to support causes aligned with the corporation's business interests, and their charitable activities are often designed to enhance the corporate image or brand.
What is a community foundation?
A community foundation is a type of public charity rather than a traditional foundation. Unlike private foundations that typically receive funding from a single source or family, community foundations garner their support from a broad public base, which can include substantial contributions from corporations and private foundations.
As the name suggests, community foundations focus their efforts on a specific locality or region. They engage directly in charitable activities and also channel grants to other non-profits within their chosen area. One key feature of community foundations is the ability they offer donors to direct the use of their contributions, such as funding scholarships or healthcare initiatives in underserved communities.
Furthermore, community foundations often manage donor-advised funds, which are individual philanthropic accounts maintained by the foundation but sponsored by donors. These allow donors to claim immediate tax benefits upon contributing, while retaining the ability to recommend specific grants to charities over time. The recommendation to make a grant is in effect an order because community foundations always follow the donor’s suggestion—exceptions are exceedingly rare.
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