Organizations described in Internal Revenue Code Section* 501(c)(3) fall into two categories:  private foundations and public charities.  Under Section 509, all organizations, domestic or foreign, described in Section 501(c)(3) are private foundations except the types of organizations described in Sections 509(a)(1), (2), (3) or (4).  “Public charities” is the generic term given to the excepted organizations.

               * All further references to “Sections” refer to sections in the Internal Revenue Code.

The distinction between private foundation and public charity classification is critical because public charity status is by far the more advantageous category where there is a choice for a number of reasons.

Private foundations are subject to additional regulation and must:

• Refrain from acts of self-dealing (Section 4941),
• Meet minimum distribution requirements (Section 4942),
• Abstain from “excess business holdings” (Section 4943),
• Abstain from “jeopardizing investments” (Section 4944), and
• Refrain from making certain expenditures (Section 4945).

Additional advantages flowing from public charity classification involve:

• Exemption from Section 4940 tax on net investment income to which most private foundations are subject,
• Less burdensome reporting requirements (the annual information return that most private foundations must complete, Form 990-PF, is more complex than the information returns filed by public charities (Forms 990 and Form 990-EZ),
• Exemption, in the case of certain public charities, from various federal excise taxes, and
• Additional fundraising opportunities due to several factors:
  • Higher dollar limitations apply to contributions made by individuals and corporations to public charities
  • Under Section 642(c), organizations classified under Section 509(a)(1) (i.e., public charities) may establish and maintain pooled income funds; other organizations described in Section 501(c)(3) may not
  • The expenditure responsibility rules of Section 4945(d)(4) make it far more likely that a public charity will receive grants from private foundations.

Public Charities:

Section 509(a)(1): an organization described in section 170(b)(1)(A) (other than in clauses (vii) and (viii)):
     (i)    Churches or conventions or associates of churches,
     (ii)   Certain educational organizations,
     (iii)   Hospital and medical research organizations,
     (iv)  Endowment funds organized and operated in connection with state and municipal colleges and universities,
     (v)   Governmental unit,
     (vi)  Publicly supported organizations described in Section 170(c)(2) that normally receive a substantial part of their support (exclusive of income received in the exercise of its exempt purpose or function) from a governmental unit or from direct or indirect contributions from the general public.  The “substantial part of support” requirement is met by satisfying a 33 1/3 percent support test or, alternatively, a “facts and circumstances” 10 percent test.  The percentages are calculated by using total support as the denominator and public support as the numerator.  Both tests generally measure an organization’s public support over a four-year period. See Public Support Tests Part I: 509(a)(1)

Section 509(a)(2):  a publicly supported organization for which its public support more typically consists of gross receipts derived from an activity that is related to its exempt function.  See Public Support Tests Part II: 509(a)(2) (note that the 509(a)(2) test is different from the 170(b)(1)(A)(vi) test).

Section 509(a)(3):  a supporting organization that meets all of the following tests:
     (A) Organizational and Operational Tests.  The organization must be organized and at all times operated for the benefit of, and to perform the function of, the specified organizations described in Sections 509(a)(1) and (2).
     (B) Nature of Relationship Test.  The organization must be operated, supervised, or controlled by, or in connection with, one or more organizations described in Sections 509(a)(1) and (2).
     (C) Lack of Outside Control Test.  The organization must be controlled directly or indirectly by one or more disqualified persons other than foundation managers and other than one or more organizations described in Sections 509(a)(1) or (2).

See Public Charities: Supporting Organizations.

Section 509(a)(4):  an organization which is organized and operated exclusively for testing for public safety.

Click here for IRS Exempt Organizations – Technical Instruction Program for FY 2003:  Public Charity or Private Foundation Status – Issues Under IRC 509(a)(1)-(4), 4942(j)(3), and 507.