CHAPTER 10
Limitation on Excess Business Holdings

  1. § 10.1 Introduction
  2. § 10.2 Excess Business Holdings: General Rules (Revised)
  3. § 10.3 Tax Imposed
  4. § 10.4 Exclusions

§ 10.1 INTRODUCTION

p. 697. Delete the regulations citation in footnote 2 and replace with the following:

Reg. § 1.501(c)(3)-1.

§ 10.2 EXCESS BUSINESS HOLDINGS: GENERAL RULES (REVISED)

p. 701. Add the following to the end of footnote 17:

See discussion in subsection 2.11(f) on contributions of LLC/partnership interest to charities.

pp. 703–704. Add the following to the end of footnote 29:

See also PLR 201414031(Apr. 4, 2014) (foundation permitted to correct excess business holdings by granting to public charities requisite amount of stock to bring foundation's holdings to 2 percent de minimis amount).

p. 704. Add the following at the end of the first paragraph on this page:

In February 2018 the Enterprise Act of 2017, as part of the Bi-Partisan Budget Act of 2018, added a provision that allows private foundations to retain 100 percent of a business under certain conditions. This will allow a private foundation to avoid the requirement to divest itself of at least 80 percent of its excess business holdings under § 4943.

New § 4943(g) permits a foundation to own 100 percent of a company provided:

  1. there are no other shareholders and the shares have been donated to the foundation or acquired in a manner other than purchase;
  2. the company must distribute all of its net operating income to the foundation within 120 days of the end of each fiscal quarter;
  3. no substantial donor to the foundation can be a director, officer, or employee of the company and the majority of the company's directors have to be persons who are not also on the foundation's board; and
  4. the company may not make loans to substantial donors of the foundation.

As referenced above, § 4943(g) was intended to provide a lifeline to the Newman's Own Foundation by allowing it to indefinitely maintain 100 percent ownership of the for-profit company founded by Paul Newman. (This exception has been referred to as the “Newman's Own Exception.”)

Although this new provision providing an exception to the business holding rules may have only limited application, it does provide planning opportunities in certain cases where the donor seeks to transfer control and ownership of a business enterprise to a private foundation. At a time when private sector philanthropy and entrepreneurship has grown, this exception permits a philanthropist to bequeath an entire business to a private foundation, provided, however, that the after-tax profits will be paid to the foundation and other stringent requirements are satisfied.

§ 10.3 TAX IMPOSED

p. 705. Delete language in footnote 34 and replace with the following:

§ 4943(a); Reg. §53.4943-2(a).

§ 10.4 EXCLUSIONS

(a) Functionally Related Business

p 706. Add the following to the end of footnote 44:

See PLR 201701002 (Jan. 6, 2017) (program providing “technical assistance” to social service nonprofit organizations held functionally related business when services had a primarily charitable purpose, had access to raw data not available to commercial ventures, and were performed by organization's employees).

p. 706. Add the following after the Example:

Assume a private foundation makes an equity investment in a functionally related LLC along with a for-profit member; although there would not be an excess business holding issue, the structure may raise unrelated business income tax questions in the event that the control test under Rev. Rul. 2004-51 is not satisfied. In this regard, see page 380.

(c) Income from Passive Sources

p. 708. Delete language in footnote 54 and replace with the following:

Passive income includes income from items excluded by § 512(b)(1), (2), (3), and (5). PLR 9412039 (Mar. 25, 1994); PLR 9250039 (Sept. 16, 1992).

p. 708. Add the following to the end of footnote 55:

See PLR 201422027 (May 30, 2014).

p. 708. Insert the following at the end of this subsection:

A private foundation often jointly invests with members of the family (i.e., disqualified persons) in an investment fund, either at its formation or thereafter. The co-investors may involve individuals, many of whom are descendants of the founder or a substantial contributor of the foundation, as well as certain trusts created by such individuals and/or partnerships or limited liability companies of which such individuals or trusts own more than 35 percent of the voting and/or profits interest. From time to time, the parties may contribute cash and may withdraw cash from the fund as well. There are numerous advantages for the foundation to co-invest with and in entities who may be disqualified persons: access to investment opportunities that have minimum investment requirements, access to the expertise of otherwise unavailable investment advisors, and economies of scale.

In a representative private letter ruling regarding foundations investing with disqualified persons, the IRS stated in part:

EXTRACT 10.1

Section 4943 of the Code expressly contemplates and permits joint or co-investments by disqualified persons and private foundations. Numerous joint or co-investment situations exist, as permitted by § 4943, where both the private foundations and the disqualified persons involved either buy or sell interests in the investment entity or make withdrawals from such entity after formation and initial funding. The passive investments contemplated by [foundation] are not considered a “business enterprise”; see § 4943(d)(3)(B). PLR 200420029.

Although the rulings in this area are fact specific, common threads are representations that the foundation is paying reasonable fees for the brokerage, tax, and portfolio services, and that no disqualified person is receiving an impermissible benefit. Thus, fund managers, who may or may not be disqualified persons as to the private foundation, must be paid reasonable compensation for such management services58 (i.e., comparable to those received by independent unrelated advisors) consistent with § 4958 and/or the self-dealing rules under § 4941(d).59

NOTES

  1. 33.1 These comments are based upon the analysis written by Richard L. Fox, the author of a treatise, Charitable Giving: Taxation, Planning and Strategies (Thomson Reuters).
  2. 33.2 Id.
  3. 58 The compensation formula typically equals a percentage of the increase in the value of the partnership assets.
  4. 59 Other rulings include PLR 200318069 (questions involving contributions to or withdrawals from investment LLC not deemed sale or exchange); PLR 200423029 (sharing of LLC investment expenses and payment of management fees not self-dealing); PLR 200548026 (§§ 4941 and 4943 issues); PLR 201630009 (receiving income from bequeathed commercial real estate properties not UBI, provided no income resulted from debt-financed property); PLR 201723006 (retaining nonvoting interests in LLC whose sole asset is promissory note from disqualified person not self-dealing when note only generates passive income in form of interest); and PLR 201737003 (foreign organization constructively owning no more than 20 percent voting stock of another company not business enterprise).
  5. 60 Details provided at: https://www.americanbar.org/content/dam/aba/administrative/taxation/policy/062216comments.authcheckdam.pdf
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