Public charities vs. private foundations: a practical guide.

• Author: Lewis, Forrest G.

In 1969, Congress subdivided Sec. 501(c)(3) organizations into two distinct classes, commonly referred to as "Public charities" and "private foundations." Because of the patchwork way in which Congress implemented the 1969 changes and because of some complex terminology, this subject continues to be a mysterious and vexing area of the tax law.

Public charities: the upper class

In reforming the rules for charitable organizations in 1969, Congress clearly intended to favor public charities - in general, organizations that draw their support from a broad base within the community, as well as certain traditionally favored institutions (such as schools, churches and hospitals). Conversely, Congress sought to restrict and regulate private foundations - usually family or corporate foundations engaged in charitable activities.

The most obvious advantage of public charity status is the more generous contribution limitations for individual donors. Under Sec. 170(b)(1)(a), an individual donor's deduction for contributions to public charities cannot exceed 50% of the individual's adjusted gross income (AGI), while contributions to private foundations are generally limited to 30% of AGI (Sec. 170(b)(1)(B)). Similarly, deductible contributions of appreciated capital gain property are generally limited to 30% of AGI if the recipient is a public charity (Sec. 170(b)(1)(c)), but only 20% if the recipient is a private foundation (Sec. 170(b)(1)(D)).

These basic contribution limits may be the most important distinction to donors. From the exempt organization's point of view, however, there are many other disadvantages to private foundation status, including the following.

[] A 2% excise tax is imposed under Sec. 4940 on the investment income of private foundations, including capital gains.

[] A penalty excise tax is imposed under Sec. 4945 on certain "taxable expenditures." Well-intentioned, but technically incorrect, grants to individuals or other foundation may run afoul of these restrictions. For example, grants to individuals for college scholarships pursuant to procedures that have not been approved in advance by the IRS are taxable expenditures. Similarly, grants to other private foundations can result in penalties if the granting foundation fails to exercise "expenditure responsibility" over the recipient foundation. (For this reason, large private foundations generally will not make grants to other private foundations.)

[] A penalty excise tax is...