What is Foundation Classification & Public Charity Status?
Part VII (7) of Form 1023 should have been at the very top of the application — but somehow it ended up at the bottom. By filing Form 1023, you’re officially petitioning the IRS to determine whether you qualify for exemption from paying all or part of your federal taxes. You’re also telling the IRS how you receive your income, and based on that info, they’ll decide which subcategory under Section 501 of the Internal Revenue Code you fit into.
The main subcategories are:
- Private Foundations
- Operating Private Foundations
- Public Charities
Here is the complete section from the IRS training manual for the agents who will determine your status. I’m giving you the ultimate answer sheet to your exam, so you need to put in some effort and read the IRS manual for Determination of Public Charity Status a few times to familiarize yourself with what IRS is looking for. Do not proceed with the next chapter unless you have read this document.
Please note: foundation classification is not the same as your NTEE code. The NTEE code classifies your organization based on its activities for statistical purposes, while foundation classification determines your tax deductibility.
In a nutshell, as I explained in the How to Start a Private Foundation guide, private foundations generally get treated worse than public charities. Why? Because the key to being a public charity is support from the general public. Congress figured that constantly having to raise money from the public would keep public charities honest. By contrast, private foundations live off income from a big endowment controlled by a select few — with no real need to prove their good works to anyone. Congress knew those foundations wouldn’t stay honest without strict regulation. And they were right.
Private foundations pay a 1% to 2% tax on their net investment income and face strict rules on transactions between themselves and their insiders, including directors. They’re prohibited from lobbying—and if they do, they pay taxes on those lobbying expenses. These, along with other forbidden expenses, are called taxable expenditures. Foundations also have to follow other regulations that don’t apply to public charities.
Gifts to private foundations are more limited in deductibility compared to other types of charities. Donors’ identities to private foundations are subject to public disclosure, and foundations face heavier reporting requirements overall. (Operating foundations, those that do charitable work beyond just grantmaking, are slightly less regulated, but not by much.)
To qualify as a public charity under the Internal Revenue Code, your nonprofit organization must meet the public charity test of 1/3 or 10%.
Public Charity Test of 1/3 or 10%
Example of 10% Public Charity Test:
Each of 11 directors gives Small Charity, Inc. $100.
Major Donor buys Small Charity, Inc. office furniture of $10,000.
Total support: $11,100.
2% of $11,100 = $220.
Major Donor’s contribution counts for only $220 of the numerator.
Equation: $1,100 (directors) + $220 (Major Donor) = 11.89% “public support” $11,100
Result: Small Charity, Inc. would fail the “1/3” test and have to argue it met the “10% + facts and circumstances” test in order to remain under 509(a)(1).
Example of 1/3 Public Charity Test:
Each of the 11 directors gives Small Charity, Inc. $100 for a total of $1,100.
The Community Foundation for Greater New Haven (a publicly supported organization) gives Small Charity, Inc. $2,000.
Total support: $3,100.
2% of $3,100 = $62
The equation is $62 x 11 directors + $2,000 = 86.5% $3,100
Result: Small Charity, Inc. passes the 1/3 support test with flying colors.
Of course refer to your Form 1023 instruction published by the IRS for the complete definition.
So how do you know if you are not a private foundation? The organization is not a private foundation because it is: (excluding, governmental churches, schools and hospitals)
- 509(a)(3)—an organization supporting either one or more organizations described in line 5a through c, f, g, or h or a publicly supported section 501(c)(4), (5), or (6) organization. Complete Schedule D.
- 509(a)(4)—an organization organized and operated exclusively for testing for public safety.
- 509(a)(1) and 170(b)(1)(A)(vi)—an organization that receives a substantial part of its financial support in the form of contributions from publicly supported organizations, from a governmental unit, or from the general public.
- 509(a)(2)—an organization that normally receives not more than one-third of its financial support from gross investment income and receives more than one-third of its financial support from contributions, membership fees, and gross receipts from activities related to its exempt functions (subject to certain exceptions).
(Next Step) Instructions For Form 1023 Part VIII – Effective Date, 27 Month Rule
(Previous Step) Form 1023 Part VI – Financial Data & Budgeting
NOTE: If you’d like to receive the following organizing documents:- Nonprofit Articles of Incorporation,
- Nonprofit Bylaws,
- Nonprofit Conflict of Interest Policy,
- Conflict of Interest Policy Acknowledgment,
- Form 1023 Attachment with all the answers,
- Form 1023 Expedite Letter template,
- and Donor Contribution Form
in Microsoft Word Document format, please consider making a donation and you’ll get to download them immediately. Not only they're worth well over $1000 in value, they will save you weeks of copy pasting and formatting as they are ready to go templates which only need changing names and addresses.
