The early stages of launching a 501 (c) (3) nonprofit can be overwhelming for a first-time nonprofit founder. Once you’ve discovered your cause, your programs, and have a plan for sustainability, the real work begins. The IRS exemption request (Form 1023) is long and tedious, and the explanations of what it means are not always clear. The first problem that can trip up application fillers is the distinction between a private foundation and a public charity.
The IRS classifies 501 (c) (3) organizations as private foundations or public charities. By far the preferred status for most nonprofits is public charity status. Private foundation status is the default, unless your organization meets the exceptions provided by public charity status. The advantages of public charity status are many and varied, and it is essential to understand the distinction between the classifications and how to fit into the public charity (when there is a choice).
Private foundations are subject to much more regulation than public charities and are restricted from acts of self-negotiation, holding excess business holdings, jeopardizing investments, and incurring certain expenses. They must also meet the minimum distribution requirements. The reporting requirements are also onerous, with a more complex information statement that must be submitted annually.
Public charities are exempt from taxes on net investment income and certain federal special taxes, where foundations must pay. Public charities are also in a better position to raise funds due to several factors. First, higher dollar limits apply to contributions made by individuals and corporations to public charities, meaning that philanthropists interested in your cause benefit more from giving high dollar donations if you are a public charity. Public charities are also the only classification of 501 (c) (3) organizations that can also establish and maintain pooled income funds. And, the spending rules under which foundations are governed make it much more likely that public charities can and will receive grants from private foundations.
There are four basic types of 501 (c) (3) organizations that qualify as public charities. Are:
1. Organizations that participate in inherently public activities: Typically, churches, schools, hospitals, and government units meet this criteria.
2. Organizations with public support: Organizations that receive a substantial amount of their financial support from the public or government, or through activities related to a purpose. This is the most common exception for 501 (c) (3) public charities, and the primary test is the 1/3 support test. That is, at least a third of the organization’s total support must qualify as public support.
3. Support organizations: Essentially created to allow foundation-like organizations to qualify as charities as long as they are closely linked to a publicly endorsed nonprofit, these organizations were abused by controlling interests. Recent changes in the law have strengthened the supervision and limitations of these opportunities.
Four. Organizations that conduct public safety tests: This provision was added for organizations testing consumer products to determine their acceptability for use by the general public.
In most cases, the best route to obtain public charity status is under the exception of publicly supported organizations. Whatever your nonprofit idea, planning for a broad base of public support will allow for highly preferable public charity status and enhance the organization’s chances of survival and prosperity.