The Bipartisan Budget Act of 2018, signed into law on Feb. 9, has a provision that may be a boon to people who want to use stock in their family businesses to fund private foundations.
Under the old law, private foundations were severely restricted in their ownership of any business enterprise, with excess amounts subject to significant taxation. Now an exception created by the budget act eliminates the tax on those private foundations with excess business holdings as long as certain conditions are met.
The exception had long been sought by the Newman’s Own Foundation, which owns 100 percent of a business that distributes all of its profits to the foundation.
The provision is one of the little-explored aspects of the new law, according to Neil Kawashima, a partner with McDermott Will & Emery in Chicago. “The rule applies to private foundations and other charitable entities that are limited in the amount of interest in a business entity that a private foundation can own,” he said.
“A private foundation is a charitable vehicle that is organized and operated exclusively for some charitable purpose,” he explained. “Typically, they are set up by an individual or a family or a company and controlled by those people. The majority of private foundations conduct their charitable activities by giving money to other charities – the types most people think of, such as schools, hospitals, churches, museums, big public organizations that help the general public, and also smaller ones like soup kitchens and libraries.”
“They’re vehicles for individuals or families or companies to give money away, but there are a number of very strict rules that limit the activities and investments of private foundations, as opposed to other types of charities” he said. “The reason is because they are generally controlled by a small group of people – as the name suggests, they are private.”
“One such rule is the prohibition against excess business holdings. This is a rule that says a private foundation in combination with a broad category of related parties known as ‘disqualified persons’ cannot own more than 20 percent of a for-profit business enterprise,” he said.
“So let’s say someone gives a private foundation 100 percent of a business in a carwash,” he posited. “The private foundation cannot hold that interest indefinitely. They will be forced to divest a significant portion of the carwash because of this rule. This has been a limitation on a number pf philanthropically inclined people, particularly those who own private businesses, because if their wealth is tied up in a private company, they can’t give assets to the private foundation without the foundation being required to sell, or at least divest a big portion of the business.”
“Under the old law, if a donor gave 100 percent of his company to a private foundation at death, the private foundation would be required to sell at least 80 percent of that company within five years of receiving it,” Kawashima explained.
Under the new provisions, a private foundation can own an operating company as long as it didn’t buy it and as long as it owns 100 percent of the voting stock, according to Kawashima. “All the profits of the business have to go to the private foundation, like the arrangement with Newman’s Own, which then will distribute the funds to charity,” he said. “In addition, the company has to be independently operated – neither the donor nor the donor’s family can be an officer or a director of the company. And also, a majority of the board of directors of the private foundation must be people who are not directors or officers of the business or family members of the donor. This creates a real separateness between the company and the foundation. And lastly, there can’t be any loan outstanding from the company to any contributors to the foundation or any family members.”
“The provision provides a wide opening for charitably inclined business owners,” he said.
The provision in the budget act was originally part of the tax reform proposal, but didn’t make it into the final bill, according to Greg Rogers, a CPA and a principal at Edelstein & Co. “It resurfaced in the budget act and was signed into law. Athough it was specifically tailored to one foundation – Newman’s Own Foundation – it opens up the opportunity for other private foundations to fully own a for-profit business as well.”
“The business was gifted to the Newman’s Own Foundation after Paul Newman passed away in 2008. Under the then-existing tax rules on excess holdings, they had five years to dispose of 80 percent of the business. The IRS does grant a five-year extension of the initial five-year period, but that was slated to end in 2018. If the foundation did not rectify this by the end of the taxable period, the tax would be 200 percent of the value of the business. Newman’s Own is a very successful business. Without the budget act provision, the tax would have put them out of business.”
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