Mark: Step four in starting your nonprofit
is to determine what type of nonprofit
you are. There are two main types of nonprofits,
public charities and private foundations.
This is a huge fork in the road that will
define your nonprofit. It will define
your operations. It will define what you do.
Very importantly, it will define how the IRS
treats you, so take this decision seriously. I am
Mark Lyda, from Lyda Law Firm. Let’s get started.
OK. So, as I mentioned, there are two main types
of nonprofits, a public charity and a private
foundation. So a public charity is what we call
operational. It’s what you think of when you think
of most nonprofits that are out there putting
on programs and operating within the community.
Whether they are putting on educational programs
or any sort of direct service opportunity,
that’s most likely a public charity.
One big requirement for public charities is that
they have to have diversified funding sources,
so that’s part of what it means to say that
they are public charities. That means that
not all of your money can come from one family
that’s setting up this nonprofit. Similarly,
the board members on the public charity cannot
all be related by family ties or by business.
And perhaps, in part, because of all of
those diversified funding sources, the IRS
does offer a benefit to the people who
contribute to the nonprofit monetarily.
The IRS allows people who donate to public
charities to deduct a higher portion of their
contributions from their income taxes.
Now, that is all in contrast to the
private foundation. A private foundation,
you probably hear of private foundations
funding other nonprofits, or underwriting
NPR, and things like that. They are private
foundations because they can be funded by
one central source, like one family, and that’s
why, often, foundations are named after families.
They are not typically operational, but rather
exist to give funding to other nonprofits.
Now, because they are private, not only can the
funding be centralized, but the board membership,
they can be all members of
the same family, for example,
and often they are. But there is some more
IRS scrutiny with private foundations because,
due to the lack of funding sources and the fact
that it can be all family members on the board.
The IRS gives that kind of extra level of
scrutiny to private foundations, just to make sure
that a private foundation is not being used
by a wealthy family as a slush fund, and
the money is actually being used for tax-exempt
charitable purposes. As part of that IRS scrutiny,
private foundations are also required to give
away 5% of their assets each year to charity.
There is a third type of nonprofit that is really
just a hybrid of the two main types of nonprofits,
and that hybrid is called a private
operating foundation. And so,
what that is, is that is a foundation
that can also do a lot of its own direct
programming. The IRS requires that
a private operating foundation use
85% of its annual income or investment
returns for tax-exempt purposes each year.
A private operating foundation is
subject to investment income tax.
However, donors can deduct their contributions
at a higher level than they would be able to if
donating to a private foundation. So that hybrid
approach of the private operating foundation, it
can sometimes be a good approach if the nonprofit
wants to put on some of its own programming,
but also devote a substantial amount to
giving money to other charities as well.
Those are the two main types of nonprofits,
a public charity or a private foundation,
plus a little bonus mixture of the two at the
end with the private operating foundation. This
is a really important decision and I have only
spoken about it in broad strokes. It’s a lot more
complicated than this. And this might be one where
it is a good idea to consult an attorney to make
sure that you are going down the right path now
that you are confronting this fork in the road.
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