Foundation Operations: Finance-> Tax Status-> Appropriate Designation
What tax status is appropriate for a new health foundation?
Foundations that receive assets from the conversion of nonprofit health care organizations can operate under several different tax status categories. The type of tax status they obtain will affect their operations, both directly and indirectly, because it carries with it certain regulatory requirements and operational expectations that have implications for the foundation's structure, including board size, staffing structure, and lobbying activities. Choice of tax status is revocable, and foundations do find reasons for changing their tax status after they have gained some experience in philanthropy. Following are definitions of the types of tax status new health foundations may obtain from the Internal Revenue Service (IRS)
501(c)(3) Tax-Exempt Organization
This is an IRS designation that entitles entities organized exclusively for charitable, educational, or scientific purposes to be exempt from most federal taxes. Many states honor the 501(c)(3) designation and confer similar exemptions for state and local taxes. Several different types of foundations fall under the 501(c)(3) tax category.
Private Foundation. A private foundation is a grantmaking foundation with an endowment from a single source such as an individual, family, or corporation. Private foundations generally do not engage in direct charitable activities but instead make grants to other nonprofit organizations. They do not raise funds from the public and must allocate assets each year to equal about 5 percent of their endowments. The funds available for grants and administrative expenses generally come from their endowment income. Private foundations also pay a 1 percent or 2 percent excise tax to the federal government as determined by an IRS formula. Subsets of private foundations include: independent foundations, with a board selected independently of the donor(s); family foundations, in which the donor or the donor's family controls the board; and corporate foundations, in which the donor corporation has selected the board.
Public Charity. A public charity is a tax-exempt religious, educational, or social service organization that receives regular contributions from several sources such as individuals, corporations, private foundations, government, and sometimes fees for services. These organizations may both operate programs and make grants. All public charities are recognized as 501(c)(3) organizations under the Internal Revenue Code (IRC). Within the 501(c)(3) category, there are subdivisions for further classifying different types of public charities, including:
- 509(a)(1) traditional. This type of public charity receives funds from public donations and/or government. It generally must meet an IRS public support test requiring that, over the most recent four-year period, its support from public sources equaled or exceeded one-third of its total support. Community foundations – which are organized to develop, receive, and administer endowment funds from private sources and manage them under community control for charitable purposes – are typically acknowledged as 509(a)(1) entities in the IRC.
- 509(a)(2) gross receipts. This type of public charity must raise more than one-third of its total support from any combination of gifts, grants, contributions, or membership fees and gross receipts from admissions, merchandise sales, or services provided in relation to its tax-exempt function.
- 509(a)(3) supporting organization. This type of organization is a nonprofit corporation with an established relationship to an existing public charity, often a community foundation or a religious order. Supporting organizations do not have to meet a public support test, and they generally receive grantmaking, investment, and administrative assistance from the nonprofit with which they are affiliated.
501(c)(4) Social Welfare Organization
This section of the IRC identifies a tax-exempt organization, known as a social welfare organization, that is allowed to lobby. These organizations include political or lobbying groups such as Common Cause or the American Association of Retired Persons. They are not obligated to spend any portion of their income or endowment on charitable activities and are not required to report the same detailed information as private foundations. A few new health foundations have obtained this status if they resulted from the sale of a 501(c)(4) medical association, insurance company, or other type of organization that had the 501(c)(4) status.