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Public Charity vs Private Foundation vs Private Operating Foundation | How to Start a Nonprofit - YouTube
Channel: Lyda Law Firm
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Mark: Step four in starting your nonprofit聽
is to determine what type of nonprofit聽聽
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you are. There are two main types of nonprofits,聽
public charities and private foundations.聽聽
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This is a huge fork in the road that will聽
define your nonprofit. It will define聽聽
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your operations. It will define what you do.聽
Very importantly, it will define how the IRS聽聽
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treats you, so take this decision seriously. I am聽
Mark Lyda, from Lyda Law Firm. Let's get started.
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Mark:聽聽
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OK. So, as I mentioned, there are two main types聽
of nonprofits, a public charity and a private聽聽
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foundation. So a public charity is what we call聽
operational. It's what you think of when you think聽聽
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of most nonprofits that are out there putting聽
on programs and operating within the community.聽聽
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Whether they are putting on educational programs聽
or any sort of direct service opportunity,聽聽
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that's most likely a public charity.
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One big requirement for public charities is that聽
they have to have diversified funding sources,聽聽
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so that's part of what it means to say that聽
they are public charities. That means that聽聽
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not all of your money can come from one family聽
that's setting up this nonprofit. Similarly,聽聽
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the board members on the public charity cannot聽
all be related by family ties or by business.
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And perhaps, in part, because of all of聽
those diversified funding sources, the IRS聽聽
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does offer a benefit to the people who聽
contribute to the nonprofit monetarily.聽聽
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The IRS allows people who donate to public聽
charities to deduct a higher portion of their聽聽
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contributions from their income taxes.
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Now, that is all in contrast to the聽
private foundation. A private foundation,聽聽
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you probably hear of private foundations聽
funding other nonprofits, or underwriting聽聽
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NPR, and things like that. They are private聽
foundations because they can be funded by聽聽
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one central source, like one family, and that's聽
why, often, foundations are named after families.聽聽
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They are not typically operational, but rather聽
exist to give funding to other nonprofits.
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Now, because they are private, not only can the聽
funding be centralized, but the board membership,聽聽
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they can be all members of聽
the same family, for example,聽聽
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and often they are. But there is some more聽
IRS scrutiny with private foundations because,聽聽
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due to the lack of funding sources and the fact聽
that it can be all family members on the board.聽聽
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The IRS gives that kind of extra level of聽
scrutiny to private foundations, just to make sure聽聽
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that a private foundation is not being used聽
by a wealthy family as a slush fund, and聽聽
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the money is actually being used for tax-exempt聽
charitable purposes. As part of that IRS scrutiny,聽聽
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private foundations are also required to give聽
away 5% of their assets each year to charity.
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There is a third type of nonprofit that is really聽
just a hybrid of the two main types of nonprofits,聽聽
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and that hybrid is called a private聽
operating foundation. And so,聽聽
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what that is, is that is a foundation聽
that can also do a lot of its own direct聽聽
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programming. The IRS requires that聽
a private operating foundation use聽聽
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85% of its annual income or investment聽
returns for tax-exempt purposes each year.
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A private operating foundation is聽
subject to investment income tax.聽聽
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However, donors can deduct their contributions聽
at a higher level than they would be able to if聽聽
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donating to a private foundation. So that hybrid聽
approach of the private operating foundation, it聽聽
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can sometimes be a good approach if the nonprofit聽
wants to put on some of its own programming,聽聽
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but also devote a substantial amount to聽
giving money to other charities as well.
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Those are the two main types of nonprofits,聽
a public charity or a private foundation,聽聽
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plus a little bonus mixture of the two at the聽
end with the private operating foundation. This聽聽
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is a really important decision and I have only聽
spoken about it in broad strokes. It's a lot more聽聽
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complicated than this. And this might be one where聽
it is a good idea to consult an attorney to make聽聽
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sure that you are going down the right path now聽
that you are confronting this fork in the road.
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If you have questions for us, please feel聽
free to drop them in the comments below聽聽
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or reach out directly. And please聽
remember to click Like and Subscribe聽聽
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to help keep legal education free for聽
small business owners and nonprofits.
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