The Internal Revenue code defines a 501(c)(3) organization as exempt from income tax if certain criteria regarding the activities of the organization are met. A 501(c)(3) organization must operate for religious, scientific, charitable, public safety testing, literary, educational, amateur sports, or the prevention of cruelty to animals purposes. Distributions from the 501(c)(3) organizations depend on how the entity was established under the Internal Revenue Code.
When an organizations applies for 501(c)(3) status on Internal Revenue Service Form 1023, the organization makes a determination as to what type of tax-exempt entity it will be, and under what sub-section of code section 501 it will operate under. The organization will initially qualify as a private foundation or a public charity. Distribution requirements are based on the entity type as determined from the initial formation on Form 1023.
Classification of private foundations include private operating foundations, exempt operating foundations, or grant-making foundations. Except for private operating foundations, a minimum distribution is required under the Internal Revenue Code. These entities must distribute at least 5 percent of the total fair market value of the trust assets, or face a severe tax penalty. If the proper amount is not distributed, then the foundation is subject to a 30 percent excise tax on the amount that was not paid. If the foundation does not correct the issue and pay out the proper amounts, the excise tax penalty will increase to 100 percent.
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Private Operating Foundation
Private operating foundations have a more favorable tax status, since they are not subject to the excise taxes imposed on other types of private foundations. Private operating foundations have more rigid qualification requirements, and are not subject to the minimum 5 percent distribution requirement that other types of private foundations have.
Public charities organized under 501(c)(3) do not have the same restrictions as private foundations . A public charity does not have minimum distribution requirements, but the Internal Revenue Service does require that at least 10 percent of the organization's expenses be collected from the public to maintain tax-exempt status.