The IRS defines a private operating foundation as a: “foundation that devotes most of its resources to the active conduct of its exempt activities.”
So what does this mean?
Unlike standard private foundations, which primarily award grants and funding to other charitable organizations, operating foundations actually run their own charitable programs. They “operate” them themselves.
So, if a foundation’s primary activity is running a charitable program (and it meets certain tests discussed in more detail below), it can be categorized as an operating foundation.
A private non-operating foundation, on the other hand, is usually created by a company, family, or single individual for the purpose of making grants to eligible nonprofits.
Most commonly museums, zoos, research facilities, and libraries are clear examples of operating foundations.
Do Operating Foundations Award Grants?
Operating foundations can be very important partners for nonprofits organizations.
For example, many libraries, research facilities, and museums are classified by the IRS as operating foundations. Nonprofits often partner with these types of organizations as they are equally invested in the betterment of their communities.
Also, even though their primary purpose isn’t to give out grants, some operating foundations still award funding to eligible nonprofits.
Take the Bill and Melinda Gates Foundation as an example.
Even though the Bill and Melinda Gates Foundation engages in its own charitable activities, it still provides grant funding to nonprofits that can partner with them in furthering their mission of fighting inequities.
Examples of Well-Known Operating Foundations
Here are several prominent examples of operating foundations.
Bill and Melinda Gates Foundation: For more than 20 years, this foundation has directly and indirectly supported charitable activities all over the world. For example, their foundation has operated programs that ensure the poorest areas of the world have clean water.
These examples illustrate how an operating foundation usually chooses one qualifying activity, whether it is providing clean water to the poor, helping children, supporting the arts, or conducting health research, and then facilitates activities to support that goal.
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There are many benefits to starting an operating foundation versus a private non-operating foundation or public charity, but there are requirements to making them work.
Operating foundations are required to spend a certain percentage of their adjusted net income or their minimum investment return (whichever is lower) on its own activities each year.
This is different from the requirement for a private non-operating foundation to pay out at least 5% of their assets in grants.
Operating foundations also must meet an income test, and then one of the following additional tests that we will discuss in more detail:
Don’t worry if you cannot meet these tests right away, as operating foundations are allocated a “good-faith determination” that they will meet these tests within their first year of existence.
But, you will eventually need to meet the income test and then also one of the above tests (asset, endowment, or support) at some point and then maintain these requirements each year to qualify for operating foundation status. We will discuss each of these requirements in more detail below.
Funding and Financial Structure
Operating foundations are dependent on meeting an income test.
To be an operating foundation, you need to illustrate (to the IRS) that most of your income is used to operate charitable programs or provide charitable (or other exempt) services.
This is demonstrated by spending at least 85% of your operating foundation’s adjusted net income or minimum investment return (whichever one is less) on these programs or activities:
Adjusted net income – your operating foundation’s net income after the gross income is adjusted for deductions.
Minimum investment return – Generally is 5% of the combined fair market value of your foundation’s assets.
As an operating foundation, the 85% spending does not include grants to public charities. Once you meet the income test, you then just need to meet ONE of the following tests: endowment, support, or assets test.
The endowment test requires your foundation to make a qualifying distribution (i.e., a contribution or endowment) toward exempt activities, and this contribution must be two-thirds of the operating foundation’s minimum investment return. Qualifying distributions include:
Other exempt purposes
For example, if you set up your operating foundation to support activities that support art and culture (i.e., a museum), then your qualifying distributions must directly support those activities. In addition, your qualifying distributions must be more than two thirds of your foundation’s minimum investment return.
If you cannot meet the endowment test, you can see if your operations and activities fall in line with either the support or assets test.
Operations and Activities
If your operating foundation is unable to make a qualifying distribution that meets the endowment test, you can see if your operating foundation meets tests on how it operates and facilitates activities. Let’s first discuss the support test:
At least 85% of the foundation’s financial support must come from the general public and 15% can come from unrelated exempt organizations. In addition:
The support from exempt organizations cannot be more than 25% of its total support.
Support received from gross investment income cannot be more than 50% of its total support.
Your foundation could also meet an asset test, which requires the foundation to use at least 65% of their assets to actively manage activities. This requirement includes:
Actively conducting exempt activities (i.e., an asset used to carry out the charitable activities), a functionally related business (i.e., a business that has the sole purpose of carrying out the charitable activities) or a combination of both;
Stock of a corporation that the foundation controls by at least 80% ownership.
If your operating foundation cannot meet the income test and one of the three other tests, you will need to report as a nonoperating foundation.
Governance and Management
Operational foundations are an attractive philanthropic option because the individuals who create them can work for the organization and have a sense of control over both its assets and programs (i.e., the operations).
If you run an operating foundation, you and your staff can receive an equitable salary for your management and government duties.
Similar to a standard private foundation, an operating foundation also has a structured governing board that helps guide the foundation. However, this governance can include family members unlike a public charity that does not allow certain board contributors.
Tax Status and Implications
“Non-operating” private foundations must adhere to what is called a 5% rule.
This rule stipulates that a private foundation must give 5% (or more) of the foundation’s annual assets in grants and qualified operating expenses to avoid paying taxes. Private operating foundations, however, are not held to this same tax standard.
This is because private operating foundations are not subject to IRC 4942(a)(1) and IRC 4942(b). These IRS sections impose taxes on private foundations if they have “undistributed income.”
This means private operating foundations are not subject to the initial and additional taxes under IRC 4942 even if they fail to distribute income under the 5% rule. In addition, operating foundations may be exempt from the net income tax imposed on other foundations.
However, even though your operating foundation doesn’t need to worry about the 5% requirement, you still have income rules that you have to follow.
You can find operating foundations on Instrumentl’s funder database. We have compiled nearly 4,000 operating foundations that have $1.32 trillion in assets. Explore the list and click on the name of the operating foundation for more information!
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Should Nonprofits Pursue Operating Foundations for Funding?
We've shown you how to find operating foundations, but how do you know if you should pursue them and put in the effort of building a grant proposal. You need to know if you'll be competitive.
Instead of reading through years of 990 data yourself, Instrumentl provides insights at a glance that reveal if a funder is right for you. Now you can quickly skim through potential funders and easily spot big picture trends like how much money they usually give out, what causes they support, their openness to new grantees, and more. All this information will save you time while grant prospecting.
Analyzing a Funder's Giving History
Using Instrumentl, you can evaluate how much a funder gave to New Grantees vs. Repeat Grantees over the years. This will help you prioritize which funders should be at the top of your focus list. Knowing how much they usually award will help you determine how much to ask for in your application.
The breakdown of funding between New vs. Repeat Grantees can also help you assess the ROI of building a relationship with this funder.
Identify Where A Funder's Money Goes
Instrumentl will show you the states a funder sends more of their awards to. This will help you determine if you'll be competitive in your ask.
The Past Grantee list can even give you ideas for organizations you can reach out to for tips or advice on how to build a relationship with the funder. You might even ask them for an introduction!
Although the main goal of an operating foundation is to actually facilitate the operation of a charitable program, some of these foundations do give out grants to nonprofit organizations.
For example, we mentioned the Bill and Melinda Gates Foundation earlier as an operating foundation. This foundation also awards grants, mostly to 501(c)(3) organizations. They post grant opportunities on their website and then nonprofits can submit a Request for Proposal.
When reviewing funders in Instrumentl, you can see which causes they most often support. You'll do this by seeing which NTEE Codes they support most often.
You can dig deeper into subclassifications. See what subcategories Average and Median Grant amounts are. The faster you can identify patterns, the faster you can prioritize the best fit funders.
Once you find an operating grant that is compatible with your project or initiative, you canstart writing your grant proposal based on the specific funding opportunity.
Why It May Be Hard To Win Funding From Operating Foundations
Although they do occasionally award grant awards, the main role of an operating foundation is to actually operate charitable programs. Because of this, they don’t offer as many funding opportunities as private non-operating foundations or government agencies. Keep this in mind as your review funders.
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Wrapping Up: The Next Steps
By now, you should understand what it takes to maintain an operating foundation. We have explained what they are, how they work, and how they can benefit your nonprofit organization.