Types of Foundations-Private
Foundations come in two basic types: private and public. Private foundations are the most common in the United States. Private foundation is a term in the IRS code used to describe any grant-making foundation that isn't supported by public money. A private foundation receives money from an individual, family, corporation or some combination of those entities. An example of a private foundation is the Bill & Melinda Gates Foundation (family foundation).
Types of Foundations--Public
Public foundations receive more than one-third of their funding from multiple donors, which can include individuals, private foundations and government. All public foundations must continue to seek funding from diverse sources in order to keep their status as a public charity. An example of a public foundation is The New York Community Trust (community foundation).
To be considered tax-exempt, that is, exempt from having to pay federal, state and local taxes, public and private foundations must be organized exclusively for purposes recognized as exempt by the IRS. To meet that requirement, grant makers must use their funding for charitable, educational, religious, scientific or literary purposes. Foundations obtain recognition of tax-exempt status by filing IRS Form 1023, "Application for Recognition of Exemption."
Regulation of Private Foundations
The regulations for private foundations are more stringent than for public foundations. Private foundations must distribute at least 5 percent of the annual average value of their assets to charitable causes. They must pay an excise tax on their net investment income. Private foundations also are restricted from "self-dealing," which are transactions between private foundations and what the IRS terms "disqualified persons," such as board members. This is to remove the potential for an individual to benefit from the foundation's largess. Private foundations also have limits on their business and investment holdings, and are limited in the amount of political advocacy they can fund. As well, some states have laws regarding private foundations. For example, some have laws limiting the composition of a board. A private foundation must also file an annual report with the IRS, called Form 990-PF. Many state charity offices also require an annual report.
Regulations of Public Foundations
Unlike private foundations, public foundations do not have a required annual payout rate. But like other public charities, they are required to file Form 990--an informational tax-return--with the IRS and state charity offices annually. Like private foundations, they can face penalties for providing more than fair market compensation to their "disqualified persons." Federal regulations also limit how much public foundations can engage in political advocacy.
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