Jane M. Searing, CPA, MS Tax, Shareholder | Clark Nuber PS
The Bipartisan Budget Act of 2018 passed a significant exception to the Excess Business Holdings rule. This exception had been included in H.R. 1 of what became the TCJ Act of 2017, but it was pulled out during the Senate reconciliation process.
Before this change, private foundations were prohibited from holding more than either a 2% de minimis holding in a business enterprise or on a combined basis with all disqualified persons of either 20% or 35% of a business enterprise. This was restrictive and frustrating for families with closely held businesses who wanted to fund the private foundation with closely held business stock.
The change in the tax law may offer some relief, but it will not be a silver bullet. The change in the tax law swings the pendulum to the other end of the spectrum. As you will see in the first requirement, ownership in the business enterprise must be 100%. There are other requirements but this is one that will require careful consideration and structuring. Still, this change opens many estate and gift planning opportunities involving private foundations.
The exception for ownership of an excess business holding has three requirements (listed as new subsection (g)(2), (3), and (4) of new IRC section 4943):
First requirement: Acquisition and Ownership
- The private foundation must own 100% of the voting stock of the business enterprise at all times during the taxable year; and
- All of the private foundation’s ownership interest in the business enterprise was acquired by means other than purchase.
Second requirement: Disposition of Profits
- Within 120 days from the close of the business enterprises’ taxable year, the business enterprise must distribute an amount equal to its net operating income for such taxable year to the private foundation.
- Net operating income = gross income
Less – deductions allowed by chapter 1 directly connected with the production of such income;
Less – tax imposed by chapter 1 on the business enterprise for the taxable year; and
Less – an amount for a reasonable reserve* for working capital and other business needs of the business enterprise.
Third requirement: Operational Independence
- At all times during the tax year, no substantial contributor1 to the private foundation or family member2 of such a contributor is a director, officer, trustee, manager, employee or contractor of the business enterprise, or an individual having powers or responsibilities similar to any of the foregoing, and
- At least a majority of the board of directors of the private foundation are persons who are not:
- Directors or directors of the business enterprise, or
- Family members of a substantial contributor to the private foundation, and
- There is no loan outstanding from the business enterprise to a substantial contributor to the private foundation or to any family member of such contributor.
There are certain tax-exempt funds and organizations which are subject to the excess business holding rules which are not eligible for this new exception. These include:
- Investments held in Donor Advised Funds (DAF) – 4943(e);
- Investments held in certain Type III Supporting Organizations – 4943(f);
- Any charitable trust described in 4947(a)(1); and
- Any split interest trust described in section 4947(a)(2).
This relief to the Excess Business Holdings rules has been lobbied for long and hard by several private foundations with significant business holdings which are 100% owned and operated to fulfill a charitable mission, but are fundamentally a profitable business enterprise. This shift in the tax law comes as welcome relief to these organizations and a fantastic estate planning opportunity to many closely held family businesses who would like to use those businesses to fund the family private foundation.
If you have questions or would like to explore how these change in the law would be beneficial to your estate and gift planning, then please contact your Clark Nuber tax team member to set up an appointment or contact us at email@example.com.
*In Accounting terms, until we have Treasury regulations defining “reasonable reserve,” Net operating income is an amount you can quantify and support.
1Substantial Contributor as defined in section 4958(c)(3)(C) is the definition used throughout this new Code section.
2Family member as defined in 4958(f)(4) is the definition used throughout this new Code section.
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