Public Charity or Private Foundation - Why Does It Matter?

Public Charity or Private Foundation - Why Does It Matter?

Article posted in Compliance on 11 September 2012| comments
audience: National Publication, Dennis Walsh, CPA | last updated: 17 July 2018


For many charitable organizations classified as a public charity, reclassification as a private foundation can have significant implications for sustainability and mission accomplishment.  In this article, North Carolina-based CPA and philanthropic consultant Dennis Walsh provides an overview of key operating, administrative, and financing issues associated with  private foundation status, as well as helpful planning tips that will help organizations maintain their public charity status.    


By: Dennis Walsh, CPA

For many charitable organizations exempt under Section 501(c)(3) of the Internal Revenue Code and classified as a public charity, reclassification as a private foundation can have significant implications for sustainability and mission accomplishment.  It is therefore important for new and mature organizations alike to know if they are at risk of losing public charity status.

The following overview of key operating, administrative, and financing issues associated with  private foundation status will help inform stakeholders and advisors of potential consequences and why it is generally preferable for an organization to stay qualified as a public charity.  Some helpful planning tips are introduced as well.   

Those contemplating a nonprofit foundation for personal philanthropy may also benefit from an introduction to private foundation characteristics.

All section references are to the Internal Revenue Code.


Congress recognizes that the Internal Revenue Service by itself cannot adequately supervise the activities of exempt organizations.  Shared government/public oversight is essential for effective administration of exempt organization law.

For nonprofits that are supported by government agencies, by other publicly supported nonprofit organizations, or broadly supported by the general public, Congress has long held that such shared government/public oversight, combined with self-policing through independent governing boards representing diverse interests, can provide sufficient public accountability.

For less transparent organizations, however, special safeguards are necessary to help deter private inurement and other abuses derived through tax-exempt status.

Use of “Foundation”

Many types of nonprofit organizations have adopted “foundation” as part of their name to help project a mission identity.  It is important to distinguish the term as used in such context from the federal tax law definition.  Its presence or absence within the organization name is not a reliable indicator of private foundation status.

Support basics

An exempt organization carries a burden throughout its existence to show why it should not be classified as a private foundation.

In order to stay qualified as a public charity, an organization will need to demonstrate annually that it receives a substantial portion of its support from the general public. However, certain organizations with an inherently publicly supported nature are essentially deemed to be a public charity and are not required to account for their public support. These include:

  • A church or convention of churches
  • An educational institution
  • Certain hospitals and medical research organizations
  • Federal, state, or local governments or a unit of such governments

As a result of the elimination of the advance ruling process in 2008, a new organization may automatically qualify as a public charity for its initial five years based on its exemption application to the IRS.

Beginning with its 6th year, an organization must annually compute qualifying support for the most recent 5 year period in order to establish why it is not a private foundation.  Therefore, an organization will need to track the sources and amounts of its support from its inception in order to complete IRS Form 990 Schedule A, Public Charity Status and Public Support, for year six and later.

If an organization qualifies as publicly supported for the current year, it will also automatically qualify for the following year.  Thus, an organization must fail to satisfy one of the public charity tests for two consecutive years before it will lose public charity status and be classified as a private foundation.

The objective of the following public charity tests are to establish that at least one-third of the organization’s “total support” qualifies as “public support.”  These two terms are defined differently for the two tests.

Organizations should first calculate their percentage of public support using a contributions-based approach (Section 509(a)(1) and Section 170(b)(1)(A)(vi)).  If the organization doesn’t qualify under this contributions-based test, it should calculate its public support percentage using a revenue-based approach described in Section 509(a)(2). 

Importantly, for either of these two support tests, a grant that would threaten public charity status is excluded from the support calculations if it is unexpected or unusual because of the amount and attracted because of the organization’s publicly supported nature.

Contributions test - Section 509(a)(1)

An organization that is supported by governmental agencies, contributions from the general public, and grants or contributions from public charities must receive at least one-third of its support from such sources over the five-year period in order to maintain public charity status.

If an organization doesn’t meet this one-third test but facts and circumstances indicate that it is publicly supported as a result of public fundraising activities, programs serving the public, and governance representing public interests, it may still qualify as a public charity if it receives at least 10% of its total support from such sources.

Key to these calculations is what to treat as qualifying support.  Excess contributions from “substantial contributors” must be excluded.  A substantial contributor is any individual or entity, other than a government agency or public charity that is publicly supported, whose total contributions over the five-year period exceed 2% of total support.  Such contributions, to the extent they exceed the 2% limit, are not counted toward meeting the one-third of support threshold.

A grant or other contribution may be considered to be received directly from a substantial contributor if made through an intermediary public charity and earmarked by a donor as expressly or implicitly for the benefit of the recipient.  If the donor is other than a public charity or governmental agency, such a grant must be excluded from the public support computation to the extent it exceeds 2% of support over the 5-year period.

This prevents the conversion of private support to public support by channeling such gifts through a public charity, as well as serving as a means to avoid the less favorable donor tax benefits from contributions to a private foundation discussed later.


Revenue test - Section 509(a)(2)

For an organization that doesn’t meet either the one-third or 10% support tests based on contributions but that receives revenue from fees or sales related to its exempt mission activities, a revenue-based  support test under Section 509(a)(2 may apply.

If the sum of contributions, membership fees, and revenue from exempt activities is at least one-third of total support, and the sum of gross investment income and net income from any unrelated business activities does not exceed one-third of total support, then the organization will qualify as publicly supported.

However, in determining support that counts toward the one-third threshold, all contributions and revenue received from “disqualified persons” is excluded. 

A disqualified person includes:

  • An officer, director, trustee, or other insider with similar powers
  • A substantial contributor
  • A person holding a more than 20% interest in an entity that is a substantial contributor
  • A family member of any of the preceding persons
  • A corporation, partnership, or trust in which any of the preceding have a more than 35% interest

For Section 509(a)(2) purposes, a substantial contributor is a person whose aggregate contributions exceed 2% of all contributions received by the organization since inception, but only if such total is more than $5,000.  Once classified as a substantial contributor, with limited exception this status is retained indefinitely.

Also excluded from qualifying support for the Section 509(a)(2) test is revenue received from any individual or government entity, other than a disqualified person, to the extent it exceeds the greater of $5,000 or 1% of total support received during the year.

See Schedule A of IRS Form 990 and the related instructions for detailed explanation and examples of these support tests.

Note:  The provisions of Section 509(a)(3) regarding the qualification of a supporting organization as a public charity are beyond the scope of this article.

Implications of Private Foundation Status

As a result of the substantial contributor and disqualified person rules, organizations that receive a significant portion of their support from a few individuals or from non-publicly supported sources such as private foundations tend to be more at risk of tipping to private foundation status.

Once an organization is classified as a private foundation, it remains a private foundation.  To regain status as a public charity, the organization must notify the IRS in advance that it intends to make a qualifying five-year termination.  Only if it meets one of the public support tests at the end of a five-year period can it again operate as a public charity.

Operating effects

Minimum distribution

A private foundation is required under Section 4942 to annually distribute for charitable purposes an amount equal to a deemed “minimum investment return.”  The minimum investment return is 5% of the value of foundation assets not used directly in carrying out exempt activities, after reduction for any related acquisition indebtedness.

Significantly, the required payout is determined without regard to the organization’s actual operating income or the performance of its income producing investments.  In some cases, this may impair the organization’s ability to build an asset base needed to realize mission potential or to accumulate a desired level of operating reserve.

Self dealing

Section 4941 specifies prohibited acts of “self-dealing” between a private foundation and a disqualified person (defined earlier).  Both a self-dealer and a participating foundation manager will be assessed separate penalties in the form of first-tier excise taxes based on a percentage of the amount involved, and more severe second-tier excise taxes may be assessed where the act of self-dealing is not timely corrected.

A foundation manager is an officer, director, or other person with similar powers.  Acts of self-dealing include:

  • Sale, exchange, or leasing of property
  • Lending of money or other extension of credit, except for an interest-free loan from a disqualified person to be used exclusively for carrying out exempt purposes
  • Furnishing of goods, services, or facilities, except where provided without charge exclusively for carrying out exempt purposes
  • Payment of compensation, Including payment or reimbursement of expenses, except where reasonable and necessary to carry out exempt purposes
  • Transfer or use of the income or assets of a private foundation

Taxable expenditures

In addition to the self-dealing rules, Section 4945 sets forth certain “taxable expenditures” that may also subject private foundations and participating foundation managers to first and second tier excise taxes, and in some cases loss of tax-exempt status.  Lobbying and grant restrictions are chief among these.

Unlike a public charity, no amount of direct or grassroots lobbying by a private foundation is permitted.  This may be especially problematic for an organization whose mission includes an otherwise permissible amount of legislative advocacy.

A private foundation that makes grants to individuals for travel, study, or similar items must obtain advance approval from the IRS of its grantmaking procedures. In addition, a private foundation generally may not grant funds to an organization other than a public charity unless it complies with the expenditure responsibility provisions of Section 4945(h).  Expenditure responsibility refers to significant and specific oversight activities including:

  • Pre-grant inquiry
  • Written agreement
  • Grantee reporting to the grantor
  • Grantor reporting to the IRS
  • Corrective action in the case of diversion of funds or other grant non-compliance

Excess business holdings

Section 4943 places a two-tier excise tax on a private foundation that invests in certain excess business interests.  In general, a private foundation may not hold a more than 20% interest in the stock of a corporation, capital interest in a partnership, or beneficial interest in a trust that is engaged in a business enterprise unrelated to its exempt functions. 

Jeopardizing investments

Section 4944 imposes a two-tier tax on private foundations and foundation managers for making investments that jeopardize the carrying out of exempt purposes.  While there is no specification of any per se jeopardizing investment, it is expected that foundation managers demonstrate ordinary business care and prudence in providing for the short and long-term financial needs of the organization.

The following table highlights excise taxes applicable to a private foundation.  A second-tier tax will apply when an act is not timely corrected as specified in the related IRC section.


Unlike the simple Form 990-N “e-Postcard” or less burdensome Form 990-EZ for use by small exempt organizations, all private foundations must file the highly technical IRS Form 990-PF annually regardless of income or asset level.  And a copy must be filed with the state attorney general even where no equivalent state requirement exists.

Most private foundations must pay an annual excise tax under Section 4940 equal to either 2% or 1% of net investment income.  This is intended to help defray added costs of government oversight of private foundations.

An organization whose total current year charitable distributions exceed the sum of 1% of net investment income, plus the result of multiplying the value of assets by the average rate of payout over the previous five years, will generally qualify for the lower tax rate.

Financing concerns

As stated earlier, a private foundation may not grant funds to other than a public charity unless it complies with the expenditure responsibility rules.  Since few private foundations will grant to another private foundation, tipping to private foundation status will likely have adverse implications on an organization’s ability to attract or sustain support from grant making foundations.

Some individual donors may be less inclined to give to a private foundation as well.  For federal income tax purposes, individuals may deduct total annual contributions of cash and capital gain property to a public charity in an amount that does not exceed 60% and 30% of the donor’s adjusted gross income, respectively.  For the same gifts to a private foundation, the annual percentage limitations are 30% and 20%, respectively. 

In addition, a gift of capital gain property to a private foundation, such as appreciated real estate, must be reduced by any long-term capital gain that would have resulted if the property had been sold at its fair market value instead.  This generally limits the deduction to the donor’s cost or other basis of the property, eliminating a deduction for appreciation in value during the donor’s period of ownership.

An exception exists for qualified appreciated stock.  This is stock for which a market quotation is readily available on an established securities market on the day of donation.  But this exception does not apply to the extent that the donor and family members contribute more than 10% of the value of the outstanding stock in the corporation.

Donor anonymity

Loss of donor anonymity may be another concern. IRS Forms 990, 990-EZ, and 990-PF alike are available from the IRS, Internet resources such as GuideStar, or directly from the organization as provided under public inspection rules.

Gifts received

Donor names and addresses for gifts received that exceed the greater of $5,000 or 2% of total current year support must be detailed on Schedule B of Form 990 or 990-PF. 

A public charity must redact donor names and addresses for such gifts on any Form 990 available for public inspection. However, such donor details must be retained on any public inspection copy of Form 990-PF.

Gifts and grants paid

Recipient information for gifts and grants made by a public charity to another organization must be detailed on Form 990 only for grants to a specific recipient totaling more than $5,000 for a year. For a grant paid to an individual, information about the nature and amount of a grant of more than $5,000 must be provided, but not the identity of the grantee.

In contrast, details of grants and contributions of all amounts made by a private foundation to organizations and individuals must be disclosed with Form 990-PF.  This includes names and addresses of individual grantees as well, except for the identity of an indigent person who received grants totaling less than $1,000 in a year.

Private Operating Foundation

Certain private foundations may enjoy some of the benefits of public charity status.  A private foundation that is actively engaged in the conduct of charitable activities, as opposed to grant making only, may qualify as a private operating foundation.  This determination is made annually by looking back at the use of foundation income and assets over the most recent four-year period.

A private operating foundation is not subject to the annual 5% payout requirement.  Instead, it has special distribution tests that afford some flexibility in the timing and amount of charitable expenditures over multiple years, as opposed to a fixed annual payout rate.  In addition, donations to a private operating foundation are tax deductible under the same rules as donations to a public charity, without regard to the private foundation limitations discussed earlier.

Perhaps most important to an organization that depends on private foundation funding, distributions to a private operating foundation qualify to be applied toward the granting foundation’s minimum distribution requirement.  But as with a grant to a private foundation, the granting private foundation must comply with the expenditure responsibility requirements.

To qualify as a private operating foundation for a particular year, the foundation must meet both an income test and one of three alternative tests:

Income test:

The foundation must spend for the active conduct of exempt activities at least 85% of the smaller of:

  • Adjusted net income (as defined in Section 4942(f), or
  • Minimum investment return (as defined earlier)

Alternative tests:

  • Assets test - 65% or more of foundation assets are devoted to the direct conduct of exempt activities
  • Endowment test - The foundation normally makes distributions in the active conduct of its exempt activities in an amount that is two-thirds or more of its minimum investment return
  • Support test - The foundation normally receives 85% or more of its support from the public and from 5 or more publicly supported organizations

An organization claims private operating foundation status annually by filing Form 990-PF and reporting this information in Part XIV.

The determination of whether an expenditure is in the “active conduct” of exempt purposes is qualitative and depends on the facts and circumstances.  In addition to the direct delivery of program services, certain grants and program related investments may qualify as active conduct expenditures depending on the foundation’s level of involvement in carrying out the supported activity.

Administrative expenses of the foundation such as salaries, travel, and other operating costs, to the extent incurred to carry out exempt purposes, may also be considered made in the active conduct, even if not otherwise associated with active conduct expenditures.

See Section 4942(j)(3) and the related Treasury Regulations for definitions and detailed requirements.

Exempt Operating Foundation

An organization that satisfies the private operating foundation tests may qualify as an exempt operating foundation under Section 4940(d)(2) if it meets certain added requirements.

In addition to the benefits of private operating foundation status, an exempt operating foundation is not subject to the Section 4940 tax on net investment income.  And of significance to organizations that rely on private foundation support, a granting private foundation is not required to comply with the more burdensome expenditure responsibility rules with respect to distributions to an exempt operating foundation.

A qualifying organization:

  • Meets the private operating foundation tests
  • Has been publicly supported for at least 10 taxable years
  • At all times during the year has a governing body at least 75% of whom are not disqualified individuals and that is broadly representative of the general public
  • At no time during the year has an officer who is a disqualified individual

For this purpose, a disqualified individual is:

  • A substantial contributor (same definition as for Section 509(a)(2) purposes)
  • A person with a more than 20% interest in an  entity that is a substantial contributor
  • A family member of either of the preceding.

A foundation must also obtain a determination of exempt operating foundation status from the IRS by filing Form 8940, Request for Miscellaneous Determination.

Planning Tips

An organization classified as a public charity should be diligent in projecting its anticipated public support from year to year, especially during its initial 5 years of existence.  Be careful to evaluate unusual grants that might otherwise count against public support.  And don’t forget to consider the alternate 10% public support test.

Because private foundation support receives adverse treatment under both the contributions and revenue-based support tests, an organization should remain mindful of the need to increase public support relative to any ongoing private foundation funding, in order to help solidify public charity status. This is especially relevant for organizations that have seen their public support shrink as the result of reductions in government funding.

Timing opportunities

Where recurring major gifts are not excludable as unusual grants, consider approaching the donor to plan receipt in a year that is not expected to negatively impact the public support outcome.

To the extent prompt receipt of the support is critical, consider borrowing the money from the donor on flexible but reasonable repayment terms, but be sure that it is a legally evidenced debt.  As payments of principal and interest are made, the donor may be willing to subsequently donate an equivalent amount to the organization in a time and manner that mitigates adverse impact on the support computation.

A key consideration for any strategy involving the timing of a gift is that if the donor unconditionally promises a gift, the income is recognized in the year it is promised, regardless of when it is received.  In the case of a loan, an additional caveat is that the organization could find itself with an unfunded debt obligation in the event the lender has a change of heart, becomes incapacitated, or dies before the gift is complete.

An organization that uses accrual basis accounting and that is able to assume the risk associated with a pledge of less than the entire gift might instead solicit separate and unrelated gifts spread over several years so that the total gifts received in any 5-year period does not cause the organization to fail the public charity test.

For an organization that uses the cash basis of accounting, securing a donor’s pledge to spread a major gift over multiple years may be all that is needed. 

Organizations seeking to qualify under the Section 509(a)(2) revenue-based public support test may benefit from “ramping up” activities that produce mission related fees and sales and thereby accelerate recognition of revenue in a suspect year.  And for organizations qualifying under either the contributions or revenue-based test, special fundraising events or capital campaigns can be similarly targeted for a year where achieving the required level of public support is in doubt.

Channeling support

As mentioned earlier, in computing the public support percentage a contribution received from a public charity that is earmarked by a donor for a particular recipient is treated as being received directly from the donor, in essence looking through the granting organization.  If the donor is an individual or private foundation, for example, such support will be subject to the substantial contributor test.  See Treas. Reg. Section 1.509(a)-3(j) for examples.

Accordingly, great care should be exercised in structuring support involving the use of an intermediary, including a donor advised fund (DAF) or other type of supporting organization.

For example, a gift from a private foundation arranged to be passed through a public charity and earmarked for an organization in danger of tipping would be clearly treated as a contribution received directly from the private foundation within the meaning of the Regulation.  On the other hand, intermittent gifts from an individual made through a DAF to a public charity with a history of significant support from the general public should normally qualify as public support received from the granting organization.

Operating foundation?

Organizations at risk of tipping to private foundation status should not overlook potential qualification as a private operating foundation or as an exempt operating foundation.  As mentioned earlier, certain forms of grant making and program related investing may qualify as active conduct expenditures, as well as routine administrative expenses for carrying out exempt functions not directly associated with the active conduct of exempt activities.

An organization that can satisfy the private operating foundation tests may wish to apply for a determination of private operating foundation status from the IRS (Section 4942(j)(3)).

This can provide assurance to a granting foundation willing to exercise expenditure responsibility that grants will count toward its minimum distribution requirement, assuming that the recipient organization continues to satisfy the annual private operating foundation tests.  In addition, individual donors contemplating current gifts including gifts of appreciated property may be assured that their donations will be treated under the more favorable rules for contributions to a public charity.

In 2011 the IRS introduced Form 8940, Request for Miscellaneous Determination, for this and certain other exempt organization determinations.  User fees vary by the type of determination requested.

Fiscal sponsorship

Founders of startup programs might consider launching the activity under the fiscal sponsorship of a public charity with compatible exempt purposes.  The sponsor should be of sufficient relative size so that recurring major gifts intended for the startup will not adversely impact the sponsor’s publicly supported status.

The startup and sponsor may agree to spin-off the startup as a separate entity when it is ready to meet the public support requirements and is otherwise ready to go on its own.

For a helpful overview of the fiscal sponsorship alternative and links to additional resources, see “Fiscal Sponsors” prepared by the National Council of Nonprofits.

Strategic combination

Where exempt purposes are compatible, consideration might be given to a strategic merger with another exempt organization receiving public support in an amount sufficient so that the ongoing public charity status of the combined entities will not be threatened by the relatively low public support of an entity at risk of tipping to private foundation.

In situations where merger otherwise makes sense, this can help the separate entities to project as a single unified organization in addition to preserving the benefits of public charity status. 

While there are numerous ways to functionally combine separate organizations, one particular option is to convert an entity with a public support problem to limited liability company (LLC) form, where permitted under state law, with a second exempt organization serving as sole LLC member.

Under IRS Revenue Ruling 67-390, a tax-exempt organization changing its form of legal entity must make a new application for exemption.  If it chooses not to reapply, then in the case of an organization converted to a disregarded entity such as an LLC, the LLC will be treated as an activity of the exempt member.

This structure requires consolidated Form 990 reporting, including the reporting of combined support on Schedule A of Form 990.  Other implications of consolidated reporting of an interest in a disregarded entity are highlighted in Appendix F of the Form 990 instructions.

There have been several private letter rulings in recent years that indicate that reapplication for tax-exempt status may not be required in all entity conversion situations.  This could potentially call into question a converted entity’s disregarded status upon conversion to an LLC.  Interested persons should be sure to check for further updates before undertaking this type of conversion.


While loss of public charity status will rarely be fatal to the conduct of mission activities, classification as a private foundation may impose added operating restrictions, administrative costs, and constraints on the organization’s ability to attract and sustain financial support.

Startup programs should evaluate the likelihood of meeting public support requirements over the foreseeable future and consider organizational alternatives when in doubt.  Established organizations should keep a watchful eye on the mix of their support from year to year and maintain a proactive planning stance.

An organization that cannot satisfy one of the public support tests but that directly conducts program activities should typically qualify as a private operating foundation. And an organization tipping to private foundation that has been treated as a public charity for at least ten years may qualify as an exempt operating foundation, provided that it conducts programs directly and that it can meet the disqualified person tests. 

At a strategic level, merger, acquisition, and collaborative opportunities may help assure public charity status over the long term.


The author wishes to thank Mig Murphy Sistrom, CPA, Durham, NC and Adam P. Cohen, CPA, West Hartford, CT for their valuable feedback in development of the article.

About the Author

Through The Micah Project, Dennis Walsh, CPA serves as a volunteer consultant to religious workers and exempt organizations, focusing on financial management, legal compliance, and organizational development. A graduate of the University of Wisconsin, he completed the Duke University certificate program in nonprofit management and is a member of the North Carolina Association of CPAs and the American Institute of CPAs.

Dennis is the author of “Legal & Tax Issues for North Carolina Nonprofits” and has written for various nonprofit publications. He actively volunteers with the Guilford Nonprofit Consortium, the Not-for-Profit Committee of the NCACPA, and for the accounting assistance program of the North Carolina Center for Nonprofits.

Mr. Walsh can be reached at

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