While this is not an exhaustive list of the types of foundations in existence, it will highlight the most popular ones used today. Most foundations, regardless of type, are formed under state law, organized and operated exclusively for charitable purposes, and are exempt from income tax under federal law.
Formation Under State Law
Foundations are formed under the laws of a particular state. Most are corporations or trusts. Foundations are formed to be operated as charitable organizations, which means they exist for the public benefit. They have no owners and no shareholders. Most often, a foundation’s initial donors select its initial directors. Successor directors are selected in accordance with principles set forth in the foundation’s governing document.
The board of directors of most foundations are self-perpetuating. This means that directors elect their successors. Subject to limitations that may be imposed in a foundation’s governing document or by applicable state law, a foundation’s board of directors can elect its own membership to successive terms of office.
Organization and Operation Exclusively for Charitable Purposes
Although foundations are formed under state law, they receive their tax exempt status under federal law. As defined under federal law, the terms ‘exempt’ and ‘tax-exempt’ do not mean “exempt from all taxes.” Rather, they mean “exempt from having to pay a federal income tax.” Foundations are required to pay an annual federal excise tax. Excise taxes in the form of penalties for noncompliance with federal rules can also be imposed.
To qualify for federal income tax exemption, foundations must be organized and operated for purposes that meet the federal definition of ‘charitable.’ Charitable purposes are broadly defined by statute and regulations to include purposes that are charitable, educational, literary, religious, scientific, testing for public safety, and preventing cruelty to children or animals.
Income Tax Exemption Under Federal Law
To be exempt from having to pay federal income tax, a foundation must receive the federal government’s written determination that it is a tax-exempt section 501(c)(3) charitable organization. To obtain that determination, the foundation must complete a written application and submit it to the IRS. The IRS registers its approval of a foundation’s tax-exempt status through its issuance of what is frequently called a “tax exemption determination letter.” This determination letter is official IRS confirmation that the foundation is exempt from having to pay federal income tax and is qualified as a charitable organization under section 501(c)(3) of the Internal Revenue Code.
So long as a foundation applies for tax-exempt status within fifteen months following the end of the month in which it was formed, the IRS’s approval of tax exemption will be retroactive to the date of the foundation's formation. Following approval, the foundation will retain its tax-exempt status for as long as it fully complies with applicable federal requirements and prohibitions.
Nonoperating Foundations and Operating Foundations
Under federal law and regulations foundations are divided into two categories: nonoperating foundations and operating foundations. Operating foundations are themselves divided into two subcategories: those that meet the definition of “exempt operating foundations” and those that don’t. The use of the word ‘exempt’ in the designation “exempt operating foundations” is intended to make it clear that such foundations are not only exempt from having to pay income tax but also exempt from having to pay an annual excise tax.
Operating foundations use most of their financial resources to run their own charitable programs. For example, an art museum formed and endowed by an individual or family. Also 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 not to run their own programs but to make grants to other charitable organizations to support program activities run by those other organizations. They are sometimes called “grantmaking foundations.” Although the principal focus of nonoperating foundations is to make grants, some nonoperating foundations allocate a portion of their resources to the running of their own charitable programs. Most foundations are 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, 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 distinction between public charities and private foundations is statutory. The basic statutory approach is to define private foundations to be all section 501(c)(3) organizations that do not qualify as public charities.
The principal basis of the distinction between a private foundation and a public charity 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 a broad base, consisting of 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.
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 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 subset of foundations, which means that all family foundations are also foundations. It also means that some foundations are not family 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 presently 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 directors 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 from family members or businesses.
- It must continue to be governed by a board of directors 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 family friends are succeeded on the board of directors by individuals who are neither family nor close friends of the family of the principal donors. At that time, the foundation becomes an independent foundation. This is true even if the term "family foundation" is retained in the foundation's name.
Corporate Foundations
Corporate foundations are foundations formed by…corporations. They can be formed as nonoperating foundations or operating foundations.
The Business of Foundations
The fact that a foundation is a tax-exempt entity does not mean that it doesn't have a business. In fact, foundations do have a business. The business of nonoperating foundations is to give away money for charitable purposes. The business of operating foundations may include giving away money for charitable purposes but is more focused on expending funds to support the operation of their own charitable programs.
In 2022, public charities reported $3.79 trillion in total assets and $2.04 trillion in total revenues. In 2022, foundations reportedly gave away $105 billion. More than 1.5 million 501(c)(3) organizations exist, of which about one hundred thousand are foundations.
