501(c)(3) vs. Private Foundation: What’s the Difference?
If you’re starting or funding a nonprofit, “501(c)(3)” sounds simple… until someone asks:
“Are we a public charity or a private foundation?”And suddenly you’re wondering:
- Does this change our tax rules?
- Can donors still deduct their gifts the way they expect?
- Are we accidentally setting ourselves up for private-foundation rules without knowing it?
First: What does 501(c)(3) actually mean?
“501(c)(3)” is the section of the Internal Revenue Code that covers most charities—schools, churches, human services organizations, arts groups, and many private foundations. If you qualify, your organization doesn’t pay federal income tax on its charitable activities, and donors may get an income-tax deduction for gifts.
Here’s the part most people miss:
Every 501(c)(3) is either a public charity or a private foundation. There is no third option.And by default, the IRS treats a new 501(c)(3) as a private foundation unless you prove you qualify as a public charity under specific rules.
Big picture: Public charity vs. private foundation
Here’s a quick side-by-side before we dive deeper:
| Issue | Public Charity | Private Foundation |
| Typical funding | Many donors / grants / program revenue | One family, one company, or a very small group |
| Typical activity | Runs programs directly (meals, classes, clinics, etc.) | Makes grants to other charities or individuals |
| Control | Broader, more independent board | Often tightly controlled by a family or company |
| Donor tax deduction | Generally more favorable limits | Deduction limits are usually lower |
| Extra IRS rules | Fewer targeted excise taxes | 5% annual payout + excise tax on investment income + strict rules |
Now let’s break down the parts that matter most for you.
Who really controls this organization?
Public charity
Public charities are meant to be, well, public.
- They usually have a diverse board with unrelated, independent members.
- They’re expected to be responsive to the community, not just one family or founder.
- Donors, regulators, and the public look to the board to protect the organization’s mission—not anyone’s private interests.
Regulators look skeptically at public charities that are actually run like private family enterprises dressed up as nonprofits.
Private foundation
Private foundations usually:
- Get most of their money from one person, one family, or one company
- Are often governed by those same people or their appointees
That level of control is allowed—but it comes with more restrictions and more IRS scrutiny to make sure the foundation isn’t just a tax-favored bank account for the family.
Where does the money come from?
This is the heart of the distinction.
Public charity: Broad public support
To be treated as a public charity, you generally need either:
- To fit into certain categories (like churches, schools, hospitals), or
- To meet a “public support” test”—in simple terms, you have to show that a substantial chunk of your support comes from the public, not just one or two major funders.
In very plain terms, the IRS likes to see that:
- Over time, roughly at least one-third of your support comes from “the public” (many donors, grants, program income), not just one or two big checks.
If you can’t meet those tests over a period of years, the IRS can reclassify you as a private foundation, with all the rules that go with that.
Private foundation: Concentrated funding
A private foundation typically:
- Receives its funding from a small number of donors (often a family or corporation)
- Relies heavily on investment income from an endowment instead of ongoing public fundraising
If your nonprofit is essentially “our family’s charitable pot,” and you don’t plan to run broad public fundraising, you’re probably in private-foundation territory.
What does the organization actually do?
Public charity:
Public charities usually run programs themselves:
- Food pantry or homeless services
- Youth programs or arts education
- Community health clinics
- Animal shelters
They raise money and then spend it directly on services.
Private foundation:
Private foundations usually:
- Make grants to public charities or, in some cases, to individuals
- Sometimes run their own small programs, but the classic model is: invest an endowment, grant out money every year
So if your plan is to build a family foundation that supports a range of nonprofits, you’re likely a private foundation. If your plan is to run the after-school program yourself, you’re more likely aiming for public-charity status.
Tax rules that actually change your day-to-day
Here’s where getting this wrong can really hurt: compliance, penalties, and donor expectations.
Annual filings
- Public charities typically file Form 990, 990-EZ, or 990-N each year, depending on their size.
- Private foundations must file Form 990-PF every year, which is more detailed and always public.
If you’re filing the wrong return—or not filing at all—you’re inviting penalties and possibly loss of tax-exempt status.
Excise tax & the 5% payout rule (private foundations)
Most private foundations must:
- Pay an excise tax on net investment income
- Make “qualifying distributions” of about 5% of their assets each year for charitable purposes
If they don’t distribute enough, the IRS can impose steep excise taxes on the undistributed amount.
That’s real money, not just paperwork.
Self-dealing and other traps (private foundations)
Private foundations face strict rules on:
- Self-dealing with insiders (loans, property, services)
- Jeopardizing investments
- Taxable expenditures (certain grants, lobbying, non-charitable spending)
Violations can trigger excise taxes on the foundation and sometimes on the individuals involved. These rules are much tighter for private foundations than for public charities.
What about your donors’ tax deductions?
This is often the question that gets donors’ attention:
“Will my donation be fully deductible the way I expect?”In general:
- Donations to public charities often have higher deduction limits (a higher percentage of an individual’s income can be deducted) than donations to private foundations.
- Donors and their advisors frequently prefer giving to public charities for that reason, especially for large gifts.
What happens if you “get it wrong”?
You might not be “wrong” in the sense of breaking the law, but you can be misaligned:
- You’re operating like a public charity but your funding is so concentrated that you’re in danger of becoming a private foundation.
- You’re operating like a family foundation, but you filed your exemption application as a public charity because it sounded better.
- You’ve never looked at the public support tests, and now your CPA tells you you’re about to fail them.
Potential consequences?
- Reclassification as a private foundation (with new taxes, new forms, and more rules)
- Donor deduction issues if you’ve been describing yourself incorrectly
- Penalties for missed or incorrect filings
- Extra scrutiny if the IRS thinks there’s private benefit or self-dealing
It’s not about scaring you—it’s about avoiding costly surprises that could have been handled early with the right structure and language in your organizing documents.
7. So which one should you choose?
Ask yourself (and your board) a few blunt questions:
- Where will most of our money come from over the next 5–10 years?
- Many small donors, grants, and program fees?
- Or one person/family/company and investment income?
- Do we want a broad, independent board—or tight family/corporate control?
- Are we primarily running programs—or primarily making grants?
- Are we prepared for the extra rules, taxes, and paperwork that come with private foundations if that’s what we really are?
Your answers point strongly toward one structure or the other. But the IRS doesn’t rely on labels or intentions—it looks at how you’re funded, how you’re governed, and how you operate over time.
Why it helps to get legal guidance early
All of this—foundation classification, public support tests, payout rules, self-dealing restrictions—is doable. But it’s a lot to navigate when you’re also trying to launch programs, hire staff, and reassure donors.
A nonprofit attorney can help you:
- Choose and document the right classification from the start
- Draft bylaws and policies that match your real-world control and funding
- Monitor your public support or private-foundation obligations year to year
- Spot self-dealing and other issues before they become IRS problems
This post is general information, not legal advice. Your facts matter: your funders, your board, your state law, and your long-term plans.
Worried You Picked the Wrong Structure? Contact Laura Brown.
If you’re looking at your board, your funding, and your donor expectations and thinking:
- “Are we actually a private foundation?”
- “Could this hurt our donors at tax time?”
- “Are we exposing ourselves to IRS penalties without realizing it?”
You don’t have to guess.
Laura Brown helps nonprofit founders, boards, and donors sort out public-charity vs. private-foundation questions before they turn into IRS problems.
If you’re:
- Starting a new nonprofit and aren’t sure how to structure it
- Running a 501(c)(3) that’s heavily funded by one family or company
- Hearing from your CPA that you might fail the public support test
…it’s time to get tailored legal guidance.
Contact Laura Brown to schedule a consultation and talk through your specific situation—so you can protect your mission, your organization, and your donors’ trust.