All nonprofits are not created equal. You're probably familiar with homeless shelters, religious organizations, animal rights groups, scientific organizations and other services that rely on volunteers and bleed money instead of make it. Despite some fundamental differences, these groups all struggle to solve the same questions: Where do we get funding, and how do we get the most from it?
The terms nonprofit, charity and foundation are often used interchangeably and inaccurately. Nonprofit describes the entity's purpose: It's a business that's not operating to earn money for its owners or shareholders. Charities and foundations, also known as 501(c)(3)s, are granted federal tax exemption by the Internal Revenue Service (IRS) based on its recognition of charitable programs. Though charities and foundations are nonprofits, not all tax-exempt organizations are charities. Some examples that qualify for tax-exempt status under other 501(c) categories are social clubs, veterans' organizations and trade associations [source: Foundation Group].
Public charities account for more than half of all 501(c)(3) organizations; as of May 2009, the IRS had records of 948,954 charities [source: McRay]. The IRS loosely defines public charities as nonprofits that are not private foundations. Although it's a vague description, the regulations we'll discuss provide a little more guidance.
Private foundations, another type of 501(c)(3), generally support the work of public charities through grants instead of administering their own programs. This type of 501(c)(3) increased 54 percent between 1998 and 2009, with 108,594 on the books as of May 2009 [source: McRay].
There's a third, but less common, type of 501(c)(3): the private operating foundation, which is somewhat of a hybrid of the other two [source: Foundation Group].
Charitable donations suffer in a down economy, so if you've got visions of starting your own nonprofit, you need to be on top of your game to succeed [source: Kadlec]. Read on to learn about the differences between 501(c)(3)s and how each type can help you accomplish a wide range of goals.
What type of nonprofit should you start?
Each type of 501(c)(3) is held to a specific set of guidelines to obtain and keep IRS nonprofit status, but it helps to make sure your group's goals are clear before you dive into paperwork.
The basic IRS nonprofit rules apply to both charities and foundations. The first paperwork you need to file is called incorporation paperwork, which outlines, among other things, how your organization will qualify as a charitable organization. You must clearly state your objectives and activities, from which point you're limited to your stated purpose. File all required IRS paperwork promptly, especially the annual Form 990. Check with your state for local laws, too. Late filing will result in fines; excessive neglect could get your 501(c)(3)'s status revoked.
By the time you file, decide what type of 501(c)(3) you'll become. Deciding factors include the relationship of the founding members. A public charity's board must be at least 50 percent unrelated by blood, marriage or business ties. A family- or business-run organization is therefore considered a foundation [source: McRay].
The organization's purpose is also relevant. Public charities actively run programs, such as homeless shelters or educational events. They must represent the public interest, which is why they're able to apply for federal funding and grants. Private foundations, on the other hand, generally support public charities or other foundations with grants, but there are exceptions, such as corporate-run foundations (which are a legal entity completely separate from, but wholly funded by, a parent for-profit company). Furthermore, foundations can be established as either a charitable trust (which disburses grants) or a nonprofit corporation (which is generally more active than a trust) [source: Foundation Center]. Though foundations might enjoy an air of mystery, with a tightly-held governance and slightly less oversight, they must still demonstrate that they're an exclusively charitable purpose.
By now, you might be wondering: Who pays for all of this? Read on to find out how public charities and private foundations are funded.
Show Us the (Tax-Deductible) Money
At this point, you should have ideas about funding. Public charities seek public support from government grants, individual donors, private foundations and other public charities. At least 33 percent of revenue must come from small donors that each give less than 2 percent of the organization's annual funding. Foundations rely on private donations from a small group, individual, family or corporation [source: McRay].
Public charities have a few advantages over private foundations. They might find it easier to attract support from financially savvy individuals, since individual financial contributors can write off donations up to 50 percent of their income. However, the tax deduction limit for individual donors to private foundations is 30 percent. The amount of the donation itself isn't limited in either case, just the portion that qualifies for tax deduction [source: Foundation Group]. Public charities have slightly easier tax filing if gross revenue doesn't exceed $25,000; public charities with higher revenues and private foundations must file the more complex Form 990-PF. Because of these benefits, public charities must prove their qualifications for the designation, or they'll be considered a private foundation by default.
Private foundations do have some advantages, however; for instance, they can be run by families or individuals related by business. There are also less strict funding restrictions, though they have to demonstrate they're actually using their resources; the IRS requires minimum asset distributions of 5 percent annually [source: McRay].
What if neither of these options suits your needs? Earlier, we mentioned a third type of 501(c)(3), the private operating foundation, which has an administration similar to a foundation, but operates its own active programs. The rules are especially strict, though. A private operating foundation must demonstrate that it qualifies for the benefits of public charities while adhering to the governance regulations of private foundations.
When you've got your board together and your documentation in order, it's time to do some good. Our Lots More Information section has links to other articles about charities, nonprofits, public service and volunteering to keep your motivation going.
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More Great Links
- Foundation Center. "What is a Foundation?" 2010. (March 23, 2010)http://foundationcenter.org/getstarted/faqs/html/foundfun.html
- Foundation Group. "Does Nonprofit, 501(c)(3) and Tax-Exempt all Mean the Same Thing?" 2010. (March 14, 2010)http://www.501c3.org/blog/frequently-asked-questions/nonprofit-501c3-terminology/
- Foundation Group. "What are the Tax Exemption Categories?" 2010. (March 14, 2010)http://www.501c3.org/blog/frequently-asked-questions/tax-exemption-categories/
- Foundation Group. "What is a 501(c)(3)?" 2010. (March 14, 2010)http://www.501c3.org/what-is-a-501c3
- Foundation Group. "What is the first step in starting a nonprofit?" 2010. (March 14, 2010)http://www.501c3.org/blog/frequently-asked-questions/first-step-starting-nonprofit/
- IRS. "Filing Requirements - Exempt Organizations." Dec. 7, 2009. (March 23, 2010)http://www.irs.gov/charities/article/0,,id=96103,00.html
- Kadlec, Dan. "Nonprofit Squeeze: Donations Down, Volunteers Up." Time. March 19, 2009. (March 23, 2010)http://www.time.com/time/magazine/article/0,9171,1886544,00.html
- McRay, Greg. "The Dirty (Half) Dozen Nonprofit No-Nos." Foundation Group. June 9, 2009. (March 14, 2010)http://www.501c3.org/blog/the-dirty-half-dozen-nonprofit-no-nos/
- McRay, Greg. "Public Charity vs. Private Foundation." Foundation Group. May 26, 2009. (March 14, 2010)http://www.501c3.org/blog/public-charity-vs-private-foundation/