The definition of private foundations

Private foundations are classified by the Internal Revenue Service (IRS) as tax-exempt section 501(c)(3) organizations with their own set of rules as laid out in the Internal Revenue Code. They are founded for charitable purposes and often established by an individual, a family, or a corporation.

A board of directors usually oversees a private foundation’s operations and its administrative functions.

Some of the administrative requirements for a private foundation include:

• Receiving and managing the assets donated
• Handling all legal documents associated with the organization
• Ensuring charitable grants are within the scope of the organization’s mission (if required)
• Investing the organization’s assets
• Succession planning
• Mandatory reporting of information about the trustees or directors, certain employees, grants, income, and investments
• Managing the salaries of anyone employed by the foundation

What is a family foundation? 

As the name implies, a family foundation is a private foundation that is founded and run by a family. A family foundation must adhere to the same rules and regulations as all other private foundations. A family foundation also generally raises money from private sources, typically from the family that founded the organization.

Family foundations are governed by a board of directors or trustees, usually comprising family members or close associates. These individuals are responsible for overseeing the foundation’s operations, making grant decisions, and ensuring compliance with legal and regulatory requirements.

Compared to donors who give directly to a public charity or to a donor-advised fund, a family member giving to their foundation will face greater limitations on their tax deduction as donors: 30% of their adjusted gross income for cash donations and 20% of their adjusted gross income for appreciated securities.

Operating vs. non-operating foundations 

In the United States, private foundations include both operating and non-operating organizations. Non-operating and operating don’t describe whether an organization is inactive or active. Instead, these terms indicate whether the organization is primarily dedicated to granting funds to other organizations (non-operating foundation) or running its own charitable programs (operating foundation).

Private operating foundations run their own programs. A private operating foundation must commit a minimum amount of its funds to its own programming. Examples of programs that a private foundation may oversee include zoos, historic properties, libraries, museums, and research facilities.

Private non-operating foundations don't need to run their own charitable activities. They instead focus on issuing grants to public charities.

Private foundations vs. public charities

What is a private foundation, and how is it different from a public charity? Public charities and private foundations are both 501(c)(3) organizations dedicated to charitable causes. However, the Internal Revenue Code directly outlines how these two charitable entities differ.

Private foundations are typically established by individuals, families, or corporations, and the founders generally maintain governance and control of the organization. Founders also generally continue to provide the organization’s funding.

Private foundations must meet certain distribution and reporting requirements dictated by the Internal Revenue Code. These requirements include making annual distributions, paying an excise tax on net investment income, and reporting contributions from donors. They are more limited than public charities regarding the tax benefits they provide to donors and the payment of executive compensation. They also face additional restrictions around grantmaking, as they must remain consistent in their mission when it comes to what types of projects and organizations they can fund.

In contrast, public charities generally rely on public support, including donations and grants from individuals, corporations, foundations, or the government. Rather than a board of directors selected only by the charity’s founders, board of director members are generally representative of the community in which the public charity operates. The Internal Revenue Code also has requirements to ensure that the members are independent of the public charity and are knowledgeable, engaged individuals who are selected with the organization’s needs in mind.

Public charities have more flexibility as they don’t face the minimum distribution requirements and grantmaking restrictions that private foundations do. Public charities also offer donors a higher deductibility threshold when it comes to donations.

These differences in types of organizations not only affect the people who start a charity, but also affect those who donate from outside the organization. Private foundations typically rely on funding from the individual, family members, or corporation that started the organization. While they can receive funds from other donors, donors receive a larger tax deduction for donating to public charities. For this reason, funding of private foundations from outside sources is far less common.

The rules of private foundations

Private foundations are charitable organizations, so they must adhere to the rules set out by the IRS to remain compliant and avoid penalties. They have complete control over running their organization and investing the assets, but this control comes with higher administrative requirements and costs.

Here are some of the rules and requirements that private foundation founders should be aware of:

• Grants and donations are public records A private foundation must annually file an IRS form 990-PF that is publicly available, reporting all contributions received and grants paid. While a donor-advised fund sponsor must submit an IRS Form 990 that is also publicly available, a DAF donor who recommends a grant to a public charity can choose to remain anonymous for public reporting purposes. Moreover, donations into donor-advised funds are also not reported publicly.
• Minimum annual distribution of 5% of the previous year's net investment assets.¹ For donor-advised funds, meanwhile, the sponsor determines the minimum distribution requirements, if any. Such requirements vary by sponsor.
• Charitable tax deductions limitations. Deductions for the donation of assets can't exceed certain adjusted gross income limitations. Donors to private foundations can only deduct cash contributions up to 30% of the donor’s adjusted gross incomes. Typically for other asset donations, donors to private foundations can deduct up to 20% of the donor's adjusted gross income. For donor-advised funds, these limitations are raised to 60% of adjusted gross income for cash donations and 30% for other asset donations. Other asset donations, such as donations of appreciated securities or complex asset donations, can include gifts of closely-held stocks, real estate, artwork, and more.
• Pay a 1.39% excise tax on net investment income. Compare this to donor-advised funds, where charitable funds grow tax-free.

Compared to the rules and regulations of private foundations, donor-advised funds are considered more cost-effective and easier to use. Many factors go into why this is typically the case, but one important consideration is that a donor-advised fund sponsor like Vanguard Charitable provides the administrative assistance involved with strategic philanthropy. This is very different to the administrative support requirements of a private foundation.

Interested in learning more? Discover how donor-advised funds work and how Vanguard Charitable can help you maximize your charitable giving.