this is Professor Russell James coming

to you from Texas Tech University

welcome to today’s lecture from visual

plan giving an introduction to the law

and taxation of charitable gift planning

welcome to private foundations part 2

private foundations versus public

charities this is Professor Russell

James there are three large classes of

charitable organizations that can

generate charitable tax deductions for

donors public charities supporting

organizations and private foundations

due to the relatively rare creation of

supporting organizations that is wealth

holding entities designed to support a

single or single set of public charities

this lecture will focus on public

charities and private non-operating

foundations public charities are

typically the organizations that

actually do charitable work private

foundations simply hold wealth and

distribute grants to these public

charities in tax law a charitable

organization is by default treated as a

private foundation all 501 C 3

charitable organizations not meeting the

guidelines for public charities or

supporting organizations are

automatically private foundations only

if the charitable entity can prove it is

a public charity or supporting

organization will it be classified as

such the two ways in which an

organization can prove it is a public

charity are by showing that it actually

engages in charitable operations for

example running a church hospital school

or homeless shelter or by showing that

it receives widespread financial support

from the public although most public

charities actually engage in charitable

activity it is possible for grant making

bodies to be public charities if they

receive widespread financial support for

example community foundations and United

appeals such as the United Way can be

public chair

even if they do not engage in charitable

operations but instead only make grants

to other public charities most private

foundations have similar characteristics

they are usually funded by a single

person family or corporation they don’t

do charitable work but instead make

grants to charities usually financial

returns on their invested assets serve

as the source of their charitable grants

rather than ongoing gifts from

fundraising this idea of a pool of

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assets set aside by one person with

charitable activity limited to issuing

grants funded predominantly from

investment income is the classic concept

of the private foundation the ways in

which a charitable organization can

avoid the default classification as a

private foundation largely Center on

demonstrating a divergence from these

classic elements of a private foundation

there are four approved pathways through

which a charitable organization can

qualify as a public charity traditional

charities qualify as public charities

because they are primarily engaged in

the day-to-day operation of delivering

charitable services in sharp contrast to

a typical private foundation these

organizations do not simply make grants

to others engaged in charitable

operations churches hospitals schools

and other traditional operating

charities qualify as public charities

rather than private foundations due to

the nature of their operations another

way that a charitable entity can be

classified as a public charity is by

having widespread financial support even

if the charity is simply making grants

and is not directly engaging in

charitable operations widespread

financial support will cause it to be a

public charity rather than a private

found a

in this first methodology the concept of

widespread financial support is a purely

mathematical issue the test is met if

the support from those who individually

give 2% or less of the total support

otherwise known as small donors sums to

at least one-third of all support given

to the charity in other words if there

are a lot of small donors who when

combined are financially important to

the organization then the organization

isn’t a private foundation instead it is

a public charity suppose a grant making

charity receives total support of

$100,000 if 35 donors gave $1,000 apiece

and the charity’s founder gave $65,000

this charity would still pass the test

for being a public charity because more

than one-third of all support came from

small donors that is those giving 2% or

less of the total support there are two

additions to this rule that prevent the

charity from being disqualified due to

financial support from government or an

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unusual large gift from an outside donor

government support is treated as small

donor support in other words less than

2% of total support regardless of how

large a share the government support

actually constitutes for example if a

non-operating grant making charity had

$100,000 of total support consisting of

a sixty five thousand dollar gift from

the charity founder and a thirty five

thousand dollar grant from the

government the charity would qualify as

a public charity

additionally unusual large gifts from an

outside donor in other words not from

the organization’s founding donor

trustees managers or their families can

be ignored so

an operating grant making organization

that otherwise would have had total

support of $1,000 apiece from 35 donors

and $65,000 from the founding donor

received an additional one-time $100,000

gift from a wealthy donor unrelated to

any of the organizations insiders if

this unusual gift were included in the

calculation it would disqualify the

organization from being a public charity

because the small donors support of

$35,000 would then constitute only 17.5%

of total support for this reason such an

unusual gift from an outsider can be

excluded from the calculation a more

subjective rule allows for small donor

support including government support to

constitute as little as 10% of the

organization’s total support however in

order to take advantage of this lower

limit the charity must also fulfill two

subjective requirements first the

charity must be operated in such a way

as to be intentionally attempting to

attract new public or government support

in other words the charity is not yet at

the one-third level but it is at 10% and

appears to be working to grow that 10%

finally the quote facts and

circumstances must suggest that it is

appropriate to treat the organization as

a public charity in a sense a charity

other than a traditional operating

charity with small donor and government

support between 1/10 and 1/3 of total

support is in a maybe zone for

qualification as a public charity this

subjectivity allows for open

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consideration of any circumstances that

might make the charity appear more like

a classic private

Foundation or more like a public charity

because of the subjectivity it may be

useful to think of this as a quote smell

test asking does this smell more like a

private foundation or a public charity

finally a charity can qualify as a

public charity based upon not only its

small donors support but also its income

from memberships

and any charitable operations if these

sum to at least one third of total

support and the charity receives no more

than one third of total support from

investment income then the charity will

qualify as a public charity for example

if a local Parent Teacher Association

received $10,000 in total income from

$4,000 in memberships $4,000 in bake

sale profits and $2,000 in investment

returns with no donations and no income

from charitable operations the

organization would qualify as a public

charity this is because at least

one-third of total support came from

memberships $4,000 which is 40% of total

support small donations in this case $0

and income from charitable operations

also $0 additionally no more than

one-third of total support came from

investment income in this case $2,000

which is 20% of total support if instead

the organization received its $10,000 of

total support from $4,000 in memberships

and $6,000 in investment returns then it

would not qualify under this rule this

large investment income more than

one-third of all support shades the

organization more into the appearance of

a private foundation a charitable

organization can qualify as a public

charity through any of these four rules

however if the charitable organization

does not qualify

by under these rules nor under rules for

supporting organizations then the

default classification of a private

foundation remains this has been private

foundations part two private foundations

versus public charities join us next

time for private foundations part three

tax rules