Foundation basics

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 are a few of the most common classifications of charitable foundations based on common usage. 

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 like to the American Red Cross. Private foundations do have the prerogative to conduct their own direct charitable programs but this practice is not widespread and is rarely deep-rooted. 

Unlike a public charity, a private foundation basically never solicits funds from the public. Instead, private foundations are 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.

Although private foundations do confer several benefits to the founder, such as a tax deduction for contributions, experts generally agree that these benefits are not sufficient reason to create and fund a private foundation. Charitable intent is considered to be the deciding factor in setting up a private foundation. All private foundations are classified as either operating foundations or non-operating foundations.  

What is an operating foundation?

Operating foundations are quite rare. They operate their own direct charitable activities as opposed to providing financial grants to other charitable organizations. Operating foundations are funded and controlled by a private source such as a wealthy family or a successful company.

The operating foundation structure can make sense for public facilities such as museums, zoos, and libraries when they are funded by a private party rather than the general public. They are completely exempt from income tax but must spend 85% of their investment income operating their own charitable projects.

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.

Any investment income earned by a non-operating foundation is taxed at the markedly low rate of 1.39%. By law, non-operating foundations must distribute approximately 5% of their assets annually toward a charitable cause.

Non-operating foundations can be further classified as independent foundations, family foundations, and corporate foundations although these classifications are not legally defined.

What is an independent foundation?

An independent foundation is a blanket term for a private non-operating foundation that receives funding from a private party. The source of funding can be an individual, a family, or a small group (e.g., many people have heard that Bill Gates and Warren Buffet have both donated vast sums to the Gates Foundation).

Independent foundations do not engage in fundraising from the general public and are controlled by their private donor group. Independent foundations that are funded and operated by a specific family are often referred to as family foundations while those controlled by a large corporation are called corporate foundations.

What is a family foundation?

Family foundations are private foundations funded and operated by members of a specific family. Sometimes the word private is added to their name dubbing them “private family foundations”. The family members of the donor control the board of directors and thereby govern and manage the foundation. It is possible for family foundations to hire family members as employees but most often family members serve on a voluntary basis without receiving compensation.

Control of family foundations can be passed down from one generation of the family to the next without limit.

What is a corporate foundation?

A corporate foundation is a private foundation funded and controlled by a corporation. The corporation and the corporate foundation are distinct legal entities. The corporate foundation’s board of directors is usually made up of company executives and employees.

Corporate foundations often receive an annual contribution from the company’s profits and can build up a considerable endowment. They frequently donate to causes that relate to their industry. Sometimes the donations are framed in such a way to improve the company’s image or brand.

What is a community foundation?

A community foundation is, legally speaking, not a foundation at all. Instead, community foundations are legally classified as public charities. In contrast to private foundations, community foundations derive their financial support from the public at large oftentimes receiving large donations from large businesses and private foundations.

Community foundations typically restrict their operations to a specific community or geographic area, hence the name “community” foundation. Community foundations conduct their own direct charitable activities and also provide grants to other charitable organizations. They typically allow their donors to designate how the donations will be used. For example, the donated funds might be restricted to a scholarship program or to support health care for the underserved in a specific neighborhood.

Many community foundations also provide donor-advised funds, which essentially are dedicated financial accounts for charitable giving sponsored by the community foundation. The donor receives a tax deduction upon donating to the donor-advised fund and can later recommend that the community foundation make grants to specific public charities. The recommendation to make a grant is in effect an order because community foundations always follow the donor’s suggestion—exceptions are very rare.

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