Foundation (United States law)
Encyclopedia
A foundation in the United States is a type of charitable organization. However, the Internal Revenue Code
distinguishes between private foundation
s (usually funded by an individual, family, or corporation) and public charities (community foundation
s and other nonprofit groups that raise money from the general public). Private foundations have more restrictions and fewer tax benefits than public charities like community foundations.
pioneered the sort of large-scale private philanthropy of which foundations are a modern pillar: John D. Rockefeller
and Andrew Carnegie
. The businessmen each accumulated private wealth at a scale previously unknown outside of royalty, and each in their later years decided to give much of it away. Carnegie gave away the bulk of his fortune in the form of one-time gifts to build libraries and museums. Rockefeller followed suit (notably building the University of Chicago
), but then gave nearly half of his fortune to create the Rockefeller Foundation
. By far the largest private permanent endowment for charitable giving created at that time, the Rockefeller Foundation was the first to became a widely understood example of the species: a standing charitable grant-making entity outside of direct control by any level of government.
Meanwhile in 1914, Fredrick Goff, a well-known banker at the Cleveland Trust Company, sought to eliminate the "dead hand" of organized philanthropy and so created the first community foundation in Cleveland. He created a corporately structured foundation that could utilize community gifts in a responsive and need-appropriate manner. Scrutiny and control resided in the "live hand" of the public as opposed to the "dead hand" of the founders of private foundations.
Starting at the end of World War II
, the United States's high top income tax
rates spurred a burst of foundations and trusts being created, of which many were simply tax shelter
s. President Harry S. Truman
publicly raised this issue in 1950, resulting in the passage later that year of a federal law that established new rigor and definition to the practice. The law did not go very far in regulating tax-exempt foundations, however, a fact which was made obvious throughout the rest of that decade as the foundation-as-tax-refuge model continued to be propagated by financial advisors to wealthy families and individuals. Several attempts at passing a more complete type of reform during the 1960s culminated in the Tax Reform Act of 1969
, which remains the controlling legislation in the United States. For more details on that legislative history, see http://www.law.nyu.edu/ncpl/library/proceedings/Conf1999TroyerPaper.pdf.
permits its use only for nonprofits with "the purpose of receiving and administering funds for perpetuation of the memory of persons, preservation of objects of historical or natural interest, educational, charitable, or religious purposes, or public welfare." The distinction between charitable organization
s and non-profit organization
s elaborates on this point.
The Internal Revenue Code defines many kinds of non-profit organizations which do not pay income tax. However, only charitable organizations can receive tax-deductible contributions and avoid paying property and sales tax. For instance, a donor would receive a tax deduction for money given to a local soup kitchen if the organization was classified as a 501(c)(3) organization, but not for giving money to the National Basketball Association, even though the NBA is a non-profit association. Neither a public charity nor a foundation can pay for or participate in partisan political activity, unless they surrender tax-exempt status including voiding the deductibility of any tax deductions for donors after the surrender or revocation date.
Tax-exempt charitable organizations fall into two categories: public charities and private foundations. A community foundation is a public charity. The US Tax Code in 26 USCA 509 governs private foundations. Meanwhile 26 USCA 501(c)(3) governs public charities.
.
Express public involvement and oversight in community foundations allow their classficiation as public charities rather than private foundations.
The differing treatment of private foundations compared to public charities including community foundations is as follows:
(a) foundation must pay out 5% of its assets each year while a public charity does not;
(b) donors to a public charity receive greater tax benefits than donors to a foundation;
(c) a public charity must collect at least 10% of its annual expenses from the public in order to remain tax-exempt while a foundation does not.
For tax purposes, there are a few variants of private foundation. The material difference is between "operating" foundations and "grant-making" foundations. Operating foundations, like Wikimedia Foundation
, Inc., use their endowment to achieve their goals directly. Grant-making foundations, like the Rockefeller Foundation
, use their endowment to make grants to other organizations, which indirectly carry out the goals of the foundation. Operating foundations have preferential tax treatment in a few areas, including allowing individual donors to contribute more of their income and allowing grant-making foundation contributions to count towards the 5% minimum distribution requirement.
Administrative and operating expenses count towards the 5% requirement; they range from trivial at small unstaffed foundations, to more than half a percent of the endowment value at larger staffed ones. Congressional proposals to exclude those costs from the payout requirement typically receive much attention during boom periods when foundation endowments are earning investment returns much greater than 5% (such as the late 1990s); the idea typically fades when foundation endowments are shrinking in a down market (such as 2001-2003).
Internal Revenue Code
The Internal Revenue Code is the domestic portion of Federal statutory tax law in the United States, published in various volumes of the United States Statutes at Large, and separately as Title 26 of the United States Code...
distinguishes between private foundation
Private foundation
A private foundation is a legal entity set up by an individual, a family or a group of individuals, for a purpose such as philanthropy. The Bill & Melinda Gates Foundation is the largest private foundation in the U.S. with over $38 billion in assets...
s (usually funded by an individual, family, or corporation) and public charities (community foundation
Community foundation
Community foundations are instruments of civil society designed to pool donations into a coordinated investment and grant making facility dedicated primarily to the social improvement of a given place...
s and other nonprofit groups that raise money from the general public). Private foundations have more restrictions and fewer tax benefits than public charities like community foundations.
History
The two most famous philanthropists of the Gilded AgeGilded Age
In United States history, the Gilded Age refers to the era of rapid economic and population growth in the United States during the post–Civil War and post-Reconstruction eras of the late 19th century. The term "Gilded Age" was coined by Mark Twain and Charles Dudley Warner in their book The Gilded...
pioneered the sort of large-scale private philanthropy of which foundations are a modern pillar: John D. Rockefeller
John D. Rockefeller
John Davison Rockefeller was an American oil industrialist, investor, and philanthropist. He was the founder of the Standard Oil Company, which dominated the oil industry and was the first great U.S. business trust. Rockefeller revolutionized the petroleum industry and defined the structure of...
and Andrew Carnegie
Andrew Carnegie
Andrew Carnegie was a Scottish-American industrialist, businessman, and entrepreneur who led the enormous expansion of the American steel industry in the late 19th century...
. The businessmen each accumulated private wealth at a scale previously unknown outside of royalty, and each in their later years decided to give much of it away. Carnegie gave away the bulk of his fortune in the form of one-time gifts to build libraries and museums. Rockefeller followed suit (notably building the University of Chicago
University of Chicago
The University of Chicago is a private research university in Chicago, Illinois, USA. It was founded by the American Baptist Education Society with a donation from oil magnate and philanthropist John D. Rockefeller and incorporated in 1890...
), but then gave nearly half of his fortune to create the Rockefeller Foundation
Rockefeller Foundation
The Rockefeller Foundation is a prominent philanthropic organization and private foundation based at 420 Fifth Avenue, New York City. The preeminent institution established by the six-generation Rockefeller family, it was founded by John D. Rockefeller , along with his son John D. Rockefeller, Jr...
. By far the largest private permanent endowment for charitable giving created at that time, the Rockefeller Foundation was the first to became a widely understood example of the species: a standing charitable grant-making entity outside of direct control by any level of government.
Meanwhile in 1914, Fredrick Goff, a well-known banker at the Cleveland Trust Company, sought to eliminate the "dead hand" of organized philanthropy and so created the first community foundation in Cleveland. He created a corporately structured foundation that could utilize community gifts in a responsive and need-appropriate manner. Scrutiny and control resided in the "live hand" of the public as opposed to the "dead hand" of the founders of private foundations.
Starting at the end of World War II
World War II
World War II, or the Second World War , was a global conflict lasting from 1939 to 1945, involving most of the world's nations—including all of the great powers—eventually forming two opposing military alliances: the Allies and the Axis...
, the United States's high top income tax
Income tax
An income tax is a tax levied on the income of individuals or businesses . Various income tax systems exist, with varying degrees of tax incidence. Income taxation can be progressive, proportional, or regressive. When the tax is levied on the income of companies, it is often called a corporate...
rates spurred a burst of foundations and trusts being created, of which many were simply tax shelter
Tax shelter
Tax shelters are any method of reducing taxable income resulting in a reduction of the payments to tax collecting entities, including state and federal governments...
s. President Harry S. Truman
Harry S. Truman
Harry S. Truman was the 33rd President of the United States . As President Franklin D. Roosevelt's third vice president and the 34th Vice President of the United States , he succeeded to the presidency on April 12, 1945, when President Roosevelt died less than three months after beginning his...
publicly raised this issue in 1950, resulting in the passage later that year of a federal law that established new rigor and definition to the practice. The law did not go very far in regulating tax-exempt foundations, however, a fact which was made obvious throughout the rest of that decade as the foundation-as-tax-refuge model continued to be propagated by financial advisors to wealthy families and individuals. Several attempts at passing a more complete type of reform during the 1960s culminated in the Tax Reform Act of 1969
Tax Reform Act of 1969
The United States Tax Reform Act of 1969 was a federal tax law signed by president Richard Nixon in 1969. The largest impact of the act was the creation of the Alternative Minimum Tax, which was intended to tax high income earners otherwise exempt from income taxes through various exemptions and...
, which remains the controlling legislation in the United States. For more details on that legislative history, see http://www.law.nyu.edu/ncpl/library/proceedings/Conf1999TroyerPaper.pdf.
Types
In the United States, "foundation" has no special legal status under Federal law (unlike "incorporated"), so an organization may have the word "foundation" in its name and not be a charitable foundation of any sort – however, state law may impose restrictions; for example, MichiganMichigan
Michigan is a U.S. state located in the Great Lakes Region of the United States of America. The name Michigan is the French form of the Ojibwa word mishigamaa, meaning "large water" or "large lake"....
permits its use only for nonprofits with "the purpose of receiving and administering funds for perpetuation of the memory of persons, preservation of objects of historical or natural interest, educational, charitable, or religious purposes, or public welfare." The distinction between charitable organization
Charitable organization
A charitable organization is a type of non-profit organization . It differs from other types of NPOs in that it centers on philanthropic goals A charitable organization is a type of non-profit organization (NPO). It differs from other types of NPOs in that it centers on philanthropic goals A...
s and non-profit organization
Non-profit organization
Nonprofit organization is neither a legal nor technical definition but generally refers to an organization that uses surplus revenues to achieve its goals, rather than distributing them as profit or dividends...
s elaborates on this point.
The Internal Revenue Code defines many kinds of non-profit organizations which do not pay income tax. However, only charitable organizations can receive tax-deductible contributions and avoid paying property and sales tax. For instance, a donor would receive a tax deduction for money given to a local soup kitchen if the organization was classified as a 501(c)(3) organization, but not for giving money to the National Basketball Association, even though the NBA is a non-profit association. Neither a public charity nor a foundation can pay for or participate in partisan political activity, unless they surrender tax-exempt status including voiding the deductibility of any tax deductions for donors after the surrender or revocation date.
Tax-exempt charitable organizations fall into two categories: public charities and private foundations. A community foundation is a public charity. The US Tax Code in 26 USCA 509 governs private foundations. Meanwhile 26 USCA 501(c)(3) governs public charities.
Community foundation
Community foundations are instruments of civil society designed to pool donations into a coordinated investment and grant-making facility dedicated primarily to the social improvement of a given place. In other words, a community foundation is like a public foundation. This type of foundation requires community representation in the governing board and grants made to improve the community. Often there will be a city that has a community foundation where the governing board comprises many leaders of the business, religious, and local interests. Such grants that the community foundation would then make would have to benefit the people of that city. For an example see the Cleveland FoundationCleveland Foundation
Established in 1914, the Cleveland Foundation was the world's first community foundation. , it is America's second-largest community foundation, with assets of $1.62 billion and annual grants of around $84 million....
.
Express public involvement and oversight in community foundations allow their classficiation as public charities rather than private foundations.
Private foundation
Private foundations typically have a single major source of funding (usually gifts from one family or corporation rather than funding from many sources) and most have as their primary activity the making of grants to other charitable organizations and to individuals, rather than the direct operation of charitable programs. When a person or a corporation founds a private foundation frequently family members of that person or agents of the corporation are members of the governing board. This limits public scrutiny over the private foundation, which entails unfavorable treatment compared to community foundations.The differing treatment of private foundations compared to public charities including community foundations is as follows:
(a) foundation must pay out 5% of its assets each year while a public charity does not;
(b) donors to a public charity receive greater tax benefits than donors to a foundation;
(c) a public charity must collect at least 10% of its annual expenses from the public in order to remain tax-exempt while a foundation does not.
Operating and non-operating
For tax purposes, there are a few variants of private foundation. The material difference is between "operating" foundations and "grant-making" foundations. Operating foundations, like Wikimedia Foundation
Wikimedia Foundation
Wikimedia Foundation, Inc. is an American non-profit charitable organization headquartered in San Francisco, California, United States, and organized under the laws of the state of Florida, where it was initially based...
, Inc., use their endowment to achieve their goals directly. Grant-making foundations, like the Rockefeller Foundation
Rockefeller Foundation
The Rockefeller Foundation is a prominent philanthropic organization and private foundation based at 420 Fifth Avenue, New York City. The preeminent institution established by the six-generation Rockefeller family, it was founded by John D. Rockefeller , along with his son John D. Rockefeller, Jr...
, use their endowment to make grants to other organizations, which indirectly carry out the goals of the foundation. Operating foundations have preferential tax treatment in a few areas, including allowing individual donors to contribute more of their income and allowing grant-making foundation contributions to count towards the 5% minimum distribution requirement.
Private foundation
The Tax Reform Act of 1969 defined the fundamental social contract offered to private foundations. In exchange for exemption from paying most taxes and for limited tax benefits being offered to donors, a private foundation must (a) pay out at least 5% of the value of its endowment each year, none of which may be to the private benefit of any individual; (b) not own or operate significant for-profit businesses; (c) file detailed public annual reports and conduct annual audits in the same manner as a for-profit corporation; (d) meet a suite of additional accounting requirements unique to nonprofits.Administrative and operating expenses count towards the 5% requirement; they range from trivial at small unstaffed foundations, to more than half a percent of the endowment value at larger staffed ones. Congressional proposals to exclude those costs from the payout requirement typically receive much attention during boom periods when foundation endowments are earning investment returns much greater than 5% (such as the late 1990s); the idea typically fades when foundation endowments are shrinking in a down market (such as 2001-2003).
See also
- Foundation (charity)Foundation (charity)A foundation is a legal categorization of nonprofit organizations that will typically either donate funds and support to other organizations, or provide the source of funding for its own charitable purposes....
- 501(c)
- Supporting organizationSupporting organization (charity)A supporting organization, in the United States, is a public charity created by the U.S. Internal Revenue Code in . A supporting organization either makes grants to, or performs the operations of, a public charity similar to a private foundation...
- Non-profit organizationNon-profit organizationNonprofit organization is neither a legal nor technical definition but generally refers to an organization that uses surplus revenues to achieve its goals, rather than distributing them as profit or dividends...