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Top 5 Issues to Consider Before Forming a 501(c)(3) Organization

1. Consider Type of 501(c)(3): In general, 501(c)(3)s are classified as either “public charities” or “private foundations”. Private foundations typically engage in passive grantmaking and are not required to receive significant public funding, whereas public charities usually engage directly in their own charitable activities and must be substantially publicly-funded based on the applicable IRS public funding test.

2. Restrictions on Activities: All 501(c)(3)s are subject to IRS operational rules that limit or prohibit certain transactions with “insiders” and other types of activities. Failure to comply with these rules can lead to significant IRS penalties and even loss of tax exemption.

3. Maintaining Tax Classification: Assuming an organization otherwise qualifies as a 501(c)(3), the primary factor the IRS analyzes determining 501(c)(3) classification is the source and amounts of funding, which can change over time. Careful funding analysis and planning are required to avoid unwelcome tax and operational consequences.

4. Classification Matters to Donors: While both private foundations and public charities afford donors tax deductions for contributions made, donations made to a public charity are generally deductible to a greater extent than donations to private foundations.

5. Can Owners Donate?: Philanthropic business owners sometimes wish to make donations of their closely-held business interests to their own private foundations. While generally permitted, the IRS imposes restrictions on this and failure to comply can lead to significant IRS penalties.

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