How to Start a Foundation
If you have money you want to donate for charitable purposes, if there is a cause that you are passionate about supporting, or if you want to create and lead a nonprofit organization that’s dedicated to making a bigger difference in the world…then you might want to find out how to create a foundation.
A private foundation is one type of tax-exempt nonprofit organization (also known as 501(c)(3) organizations) that receives special tax-exempt status from the IRS. If your private foundation qualifies, you can operate as a tax-exempt charitable organization that does not have to pay federal income tax and can collect tax-deductible contributions from donors.
There are a few important differences between a private foundation and other types of 501(c)(3) nonprofit organizations. Your plan for starting a foundation should depend on what you want to accomplish with your foundation and how it will receive funding.
Becoming a Tax-Exempt Charitable Organization
Under U.S. tax law, there are a few types of nonprofit organizations that can receive tax-exempt status — but these nonprofit organizations must be dedicated to specific “exempt purposes” that allow them to qualify as tax-exempt. The IRS defines these exempt purposes as: “Charitable, religious, educational, scientific, literary, testing for public safety, fostering national or international amateur sports competition, and preventing cruelty to children or animals.”
Qualifying Charitable Purposes
Starting a foundation requires setting up a nonprofit organization that is dedicated to charitable purposes. The IRS website defines “charitable” in a legal sense as including:
- Relief of poor, distressed or underprivileged people
- Advancement of religion, education or science
- Erecting and maintaining public buildings, monuments or works
- Lessening the burdens of government
- Lessening neighborhood tensions
- Eliminating prejudice and discrimination
- Defending human rights and civil rights
- Fighting community deterioration and juvenile delinquency
If your foundation has a focused mission that fits into one or more of these categories, it will probably qualify as meeting the standard for charitable “exempt purposes,” and you should continue the process of applying to start a foundation.
Private Foundation vs. Public Charity
Within the category of 501(c)(3) charitable organizations, there is a difference between “charitable organizations,” “public charities” and “private foundations.” You need to know whether your idea for a foundation is the right fit for being classified as a “private foundation” or if you should set it up as a different type of nonprofit organization.
For example, as described on the IRS website, “public charities” are a type of charitable organization that typically consist of:
- Churches, hospitals, or qualified medical research organizations affiliated with hospitals, schools, colleges and universities
- Organizations that actively raise funds and receive contributions from many sources, including corporations, the general public, government agencies, private foundations or other public charities
- Organizations that receive income by conducting activities in furtherance of the organization’s exempt purposes, or that actively work in a supporting relationship to one or more other public charities
Meanwhile, private foundations typically have just one major source of funding (such as donations from one family or corporation). Private foundations usually do not have a direct responsibility for operating charitable programs — instead, foundations help fund other nonprofit organizations and charitable work by making grants to other charitable organizations and individuals.
How to Create a Foundation: Step By Step
Starting a foundation is similar to setting up other types of nonprofit organizations. As described by the IRS, there are several steps in the process of how to start a foundation:
1. File organizing documents: This can include a corporate charter, articles of association, or other official documents to create your foundation as a legal nonprofit entity under state law.
2. Write by-laws: Your state may require your foundation to have by-laws, which are internal operating rules to govern your foundation. For example, your foundation’s by-laws might specify more details about the mission and purpose of your foundation and include instructions on how your foundation will operate in a way that complies with regulations.
For example, here are a few of the restrictions and requirements for private foundations:
- Private foundations are required to file an annual Form 990-PF with the IRS
- Foundations must abide by limits on investing in private businesses
- Foundations must distribute income for charitable purposes each year
- Foundations must avoid self-dealing between the foundation and its substantial donors or other “disqualified persons”
- Foundations must spend money in a way that advances the mission of their tax-exempt charitable purposes
- Foundations’ investments must not “jeopardize the carrying out of exempt purposes.”
Violating these rules can lead to taxes and penalties against the foundation and its managers, members and contributors.
3. Get an Employer Identification Number (EIN) for your foundation: Even if your foundation will not have employees, you need an EIN to identify your foundation as a legal tax-exempt organization with the IRS. Getting an EIN will also help you set up a bank account for your foundation and otherwise manage official paperwork and compliance requirements. You can apply for your EIN online if your foundation is based in the U.S. or U.S. Territories, and if you have a valid Taxpayer Identification Number (TIN) — Social Security Number, EIN from another existing business or ITIN.
4. Decide what type of private foundation you want to be: For tax purposes, it might be necessary for you to specify what type of foundation you want to operate. There are three main types of private foundations:
- Private Operating Foundation: This type of foundation devotes most of its resources to actively conducting charitable efforts for its tax-exempt activities, instead of just funding the activities of other charities or organizations. Qualifying as a private operating foundation can help your foundation avoid the excise tax on failure to distribute income.
- Exempt Operating Foundation: This type of foundation has been publicly supported for at least 10 years, and can apply to qualify for exemption from federal tax on net investment income. To obtain status as an exempt operating foundation, the organization needs to file Form 8940 with the IRS.
- Grant-making Foundation: This type of foundation does not do a significant amount of direct charitable activities and instead is focused on donating money and making grants.
5. Register with your state charity officials: In order to solicit charitable donations in your state, your foundation must register with one or more state agencies in the local state where your foundation was formed. Specific rules and registration requirements vary by state; refer to the IRS website for more details.
Setting up a foundation can be complex, but the rewards are worth the effort. If you follow the rules and qualify according to the compliance requirements, you can create a long-lasting foundation to support causes that you care about, give more generously in a tax-advantaged way, and leave a lasting legacy of doing good in the world.
Are you ready to start a foundation or other 501(c)(3) organization? Talk to Incfile today! We offer a variety of premium nonprofit services to help get your foundation launched, approved and on track for success.