The following legal definitions are adapted from the first chapter of Charitable Foundations: the Essential Guide to Giving and Compliance, by Daniel N. Belin, a lawyer and consultant with more than 40 years of experience working with foundations and their managers. He has served on the boards of a number of foundations and charities.
Operating Foundations and Nonoperating Foundations
Under federal law and regulations, foundations are divided into two categories: operating foundations and nonoperating foundations.
Conceptually, operating foundations are foundations that use most of their financial resources to run their own charitable programs. Examples are art museums formed and endowed by one individual or one family and foundations formed by artists to catalog their works and to further their philanthropic and educational initiatives.
In contrast, nonoperating foundations generally use the bulk of their resources to make grants to other charitable organizations to support program activities run by those other organizations. They are sometimes called “grant-making foundations.” Most foundations are nonoperating foundations.
While operating foundations apply most of their resources to the direct support of their own charitable programs, some operating foundations also maintain programs through which they make grants to other charitable organizations. Similarly, although the principal focus of nonoperating foundations is to make grants, some allocate a portion of their resources to the running of their own charitable programs.
Under federal law, operating foundations are not subject to all the legal requirements imposed on nonoperating foundations. For example, operating foundations are not subject to the same annual distribution requirements that are imposed on nonoperating foundations.
Public Charities and Private Foundations
Under federal law and regulations, all section 501(c)(3) organizations are classified as either “public charities” or “private foundations.” If a section 501(c)(3) organization is not one, it’s the other. It cannot be both, and it cannot be neither.
The determination of whether a section 501(c)(3) organization is a public charity or a private foundation has nothing to do with whether the word “foundation” is in the organization’s name. For example, the Michael J. Fox Foundation for Parkinson’s Research; the Robin Hood Foundation; the Bill, Hillary & Chelsea Clinton Foundation; and the California Community Foundation are all public charities, not private foundations. The Carnegie Corporation of New York; the Lilly Endowment, Inc.; and the Duke Endowment are all private foundations.
The principal distinction between a private foundation and a public charity, by statute, relates to the degree to which the organization receives a broad base of public support.
Public charities generally receive most of their financial support from the general public, corporations, foundations, other public charities, and governmental sources. They generally fund their operations from annual contributions from these sources.
In contrast, most foundations receive endowments and regular contributions from one donor or a limited number of donors. They traditionally support their ongoing charitable activities with funds from those limited sources.
Distinctions between private foundations and public charities, and between private nonoperating foundations and private operating foundations, can be of considerable legal importance. For example, a nonoperating foundation may not make a grant to another nonoperating foundation without complying with “expenditure responsibility” requirements. If it does so, substantial penalty taxes can be imposed. In contrast, a nonoperating foundation can make fully qualified grants to most types of public charities without taking any burdensome pre-grant steps.
Community Foundations and Public Foundations
Community foundations usually hold funds contributed by a large number of donors. Some of these funds are called “donor-advised funds.” Community foundations are generally formed to address charitable needs in particular geographical areas. Examples are the New York Community Trust and the California Community Foundation.
Public foundations are generally formed to provide financial support to particular public facilities. They frequently but not always have names that include words such as “public library foundation,” “public schools foundation,” or “park foundation.”
Nearly all 501(c)(3) organizations that call themselves “community foundations” or “public foundations” are in fact public charities and not private foundations. Being public charities, they are not subject to the specific federal requirements and prohibitions imposed only on private foundations.
Family Foundations and Independent Foundations
Although the term “family foundation” is not defined in the law, its meaning is well understood. Family foundations are a category — a subset — of foundations. Foundations that are not family foundations are frequently called “independent foundations.”
The difference between an independent foundation and a family foundation comes down to how the foundation was formed and how it is governed. To be a family foundation, the foundation must meet three tests:
- It must have been formed by one or more family members with a view toward its trustees being family members and perhaps a few close family friends.
- It must have been endowed by family members or family-owned businesses or regularly receive “pass-through” financial support — more on these gifts below — from family members or businesses.
- It must continue to be governed by a board of trustees consisting of family members and close family friends.
Many foundations initially were — but no longer are — family foundations. This type of transition occurs as family members and friends are succeeded on the board of trustees by individuals who don’t have the same relationships to the principal donors. At that time, the foundation becomes an independent foundation. This is true even if the term “family foundation” remains in the foundation’s name.
Corporate Foundations
Corporate foundations are foundations formed by corporations. They can be formed as nonoperating foundations or operating foundations.
Pass-Through Foundations
The concept of a pass-through foundation is that its principal donor makes periodic contributions to the foundation. If the pass-through foundation is a grant-making, nonoperating foundation, it distributes most of the funds it receives shortly after their receipt. If it is an operating foundation, it uses most of the funds it receives to run its own programming. A pass-through foundation is more likely to be a nonoperating foundation than an operating foundation.
Artists’ Foundations
The term “artists’ foundations” is generally applied to describe foundations formed by individuals who have achieved success as artists. Examples of those artists include composers, choreographers, authors, filmmakers, performing artists, and visual artists.
An artist might form a foundation for a variety of purposes. For example, a choreographer might form a foundation to hold ownership rights to her or his own choreography, to license the use of that choreography, and, with licensing proceeds, to provide scholarship assistance to students of dance. Artists’ foundations can also serve to protect the use and integrity of artistic achievements. For example, a foundation formed by a visual artist could assume responsibility for determining whether works of art purporting to be in the artist’s own hand are authentic or forgeries, or to create a comprehensive list with descriptions — a catalogue raisonné — of the artist’s works.
The donor-artist makes the initial determination of whether the foundation will be a nonoperating foundation or an operating foundation.
Daniel N. Belin is the president of Belin Consulting. He can be reached by email at db@belin-consulting.com.