Many clients are interested in creating a charity to accomplish their charitable objectives. However, there is much confusion over charities and tax exempt entities in general.
First, a tax exempt entity is not necessarily a charity, and not all charities are created equal. A tax exempt entity simply means that income generated by the entity is not subject to income tax. The tax exempt entity could be a charity or, for example, a trade association, a labor union or a fraternity. These organizations are described in Section 501 of the Internal Revenue Code.
Charities are distinguishable from other tax exempt entities because they satisfy a charitable purpose (i.e., "501(c)(3) organizations"). Charitable purposes are varied, but they include, for example, religious, health, educational and scientific purposes, and more general purposes such as helping the poor. The advantage of being a charity compared to other tax exempt entities is that contributions to charities are tax deductible. However, as alluded to above, not all charities are treated the same. Charities can be public charities or private foundations. As the chart at the end of this Post illustrates, there are advantages to being a public charity. Contributions to public charities are deductible at 50% of adjusted gross income ("AGI") versus 30% of AGI for a private foundation. Further, the general rule for contributions of stock to a public charity is that deductions are at fair market value at 30% of AGI, versus the stock basis and 20% of AGI for private foundations. Public charities also are not subject to various excise taxes that apply to private foundations.
What distinguishes a public charity from a private foundation? Generally public charities receive a substantial part of their support from the general public. Therefore, the perception is that, with the general public serving as a watchdog, there is not as much government regulation required as with a private foundation. On the other hand, private foundations are created and funded solely by wealthy donors. There may be greater opportunity for the donors to take advantage of the charitable rules for their personal benefit with a private foundation than with a public charity.
Whether you create a public charity or a private foundation the process is the same: it starts with forming an entity under state law, and filing IRS Form 1023 with the IRS. Alternatives to private foundations are donor advised funds and community foundations, which may provide similar benefits but less paperwork and maintenance. They are the subject of a future Post.
Public Charity Private Foundation Income Tax Deduction Cash 50% AGI 30% AGI Appreciated Property 30% AGI (FMV) 20% AGI (Basis)* Estate Tax Deduction 100% 100% * General rule; marketable securities may receive fair market value deduction.
Income Tax Deduction
Estate Tax Deduction
* General rule; marketable securities may receive fair market value deduction.