Nonprofit Sector 101

An introduction for private foundations
Excerpted from The Foundation Guidebook



“Nonprofit sector” collectively describes the institutions and organizations in American society that are neither government nor business. Nonprofit is a layperson’s term describing a wide range of organizations – including private foundations – that contribute to the public good. The nonprofit sector in the United States contains more than 1.5 million nonprofit organizations comprising at least 7 % of the U.S. gross domestic product.

Because nonprofit organizations offer programs and services that would otherwise have to be provided by the government, the government excuses them from the taxes that for-profit businesses must pay. A private foundation receives this special tax-exempt classification when created, and with this classification comes a responsibility to act on behalf of and uphold the public trust.

Section 501(c) of the federal tax code outlines the more than 25 types of organizations eligible for tax exemption. Below, we describe briefly the 501(c)(3) classification, as this is most relevant to private foundations and their grantmaking.

501(c)(3) organizations are “organized and operated exclusively for religious, charitable, scientific, testing for public safety, literary or educational purposes.…” The tax code divides 501(c)(3) organizations into five types of organizations:

  • Traditional public charities
  • Gross receipts public charities
  • Supporting organizations
  • Public safety organizations
  • Private foundations


Traditional public charities - 509(a)(1), also known as 170(b)(1)(A); and gross receipts public charities –  509(a)(2)
When someone thinks of a nonprofit, these organizations are the types that typically come to mind. Think hospitals, museums, schools, homeless shelters, and the like. Classification is based on a purpose to serve the public or by receiving a third or more of total income from the public. Community foundations also receive this designation because of the public support they receive.

Private foundations with a desire for minimal paperwork often state: “Our foundation funds only 501(c)(3) organizations.” But if minimal paperwork is the goal, it is better to state: “Our foundation funds only 501(c)(3) organizations with a 509(a)(1) or 509(a)(2) designation.” Making grants to certain 509(a)(3) supporting organizations, a 509(a)(4) organization, or another private foundation (all of which are 501(c)(3) organizations) requires additional paperwork at a minimum and may not count toward the 5% payout.

Supporting organizations – 509(a)(3)

Supporting organizations are not publicly supported, but rather closely associated with another public charity. Examples include some university or hospital foundations; foundations created to support libraries, elementary schools, or other government units; and personal trusts created to benefit specific public charities. Supporting organizations are further classified into Types I, II or III depending on the degree of control held by the affiliated public charity over the supporting organization.

Important note: While you may hear little about 509(a) organizations, this is the designation that should matter most to you as a grantmaker, as grants to certain types of 509(a) organizations are excluded from counting toward your 5% payout. Don’t settle for simply knowing that an organization is classified as a 501(c)(3).

Public safety organizations – 509(a)(4)

Few organizations qualify under this designation, but it is important to know that grants to 509(a)(4) organizations (e.g., American Fireworks Standards Laboratory) require additional paperwork.

Private foundations

Private foundations are one of the most complex components of the nonprofit sector. Defined in the tax code by what it is not – that is, not a 509(a)(1), (2), (3), or (4) – a private foundation:

  • Is a charitable organization
  • Is often funded from one source (usually an individual, family, or business) rather than the public
  • Derives its revenue from investments (i.e., endowment fund)
  • Makes grants to other charitable organizations as its main activity, except in the case of private operating foundations

Because private foundations are more private in nature than public charities, often with little input or funding from the public, they are subject to more stringent regulation and reporting requirements than public charities. It is important to understand this distinction between public and private.

The most common types of private foundations are listed below:

  • Private non-operating foundations usually have a single source of funding (an individual, family, or business) and use income from investments to make grants to other nonprofit organizations. The Ford Foundation, the Carnegie Corporation, and the W.K. Kellogg Foundation are examples.
  • Private operating foundations use the bulk of their resources to carry out their own charitable programs, rather than make grants to other nonprofits. The Carnegie Endowment for International Peace and the Getty Trust are examples. They have a more favorable tax status because they operate their own programs.
  • Corporate foundations are private foundations that receive funding from and make grants on behalf of a corporation. The Metropolitan Life Foundation is just one example.

Note: The term “family foundation” is commonly used in philanthropy, though it is not a legal designation. Generally, a foundation falls into this category if the donor’s family, however distant, still has significant influence over governance of the foundation. Foundations that do not have this familial participation are “independent foundations.”