The Business Of A Private Foundation
Contributing Author: William A Raabe
The 2018 Budget Act, signed into law on February 9, 2018, included an interesting exception from the long-standing rule that a private foundation can’t own an operating for profit business.
SWFT Volume 2 Chapter 15 Exhibit 14.4 explains that an excise taxes applies to private foundations that own more than 20% of shares in an unrelated business. To discourage business owners from transferring an operating business to an exempt entity during life or death, the tax on excess business holdings was established in 1969. This is to avoid Federal income taxes on the profits. The annual SS4943 Tax is 10% of the business value that the private foundation holds.
The new exception was to have been included in the Tax Cuts and Jobs Act 2017 but was not. The new SS4943(g), which is effective for tax years beginning after 2017, has been added. It defines an entity for which the excise taxes are waived. This creates the term “philanthropic business”, which sounds like an absurdity.
What type of business enterprise is eligible for the SS4943 (g) waiver of excess business holdings excise taxes? Ask your students to think about the company that makes salad dressings, and other food products under “Newman’s Own.” They may have seen or used it. Paul Newman, an actor, created and managed for many years a company that distributed popular food products. The Newman’s Own Foundation holds the stock of the company. All profits from the company have been donated to charities, often supporting liberal causes. Newman could thus state that he did not make any personal profit from the products bearing his name or likeness.
Newman’s Own boasts the high quality products it makes and one of its slogans is “100% Profits to Charity.” Newman is quoted saying that the company started as a joke but grew into a huge business. The product range includes dressings and sauces, coffee, tea, wine and pet food. The Foundation has donated over half a million dollars to charity. The public has access to financial and tax information regarding the Foundation.
The Foundation has been lobbying Congress for the amendment to law for approximately a decade, roughly from the date of actor’s death. Because it was so closely associated with the business, some refer to the provision as the “Newman’s Own Exemption”. Students can use the Foundation to help them describe the most important requirements of the exemption from the excise taxes.
Through the 100% stock ownership of the private foundation, the business operations are managed by the private foundation.
Private foundations received their shares as gifts, bequests, or other arrangements that were not purchases.
The private foundation board cannot have a majority of its members drawn from the board/officers of a business or the family of the founder.
Directors, officers, employees, and contractors of the family of the founder cannot be part of the business. These parties cannot be loaned money by the business.
All profits from the company must be given to the private foundation. To cover business emergencies, a reasonable reserve is allowed.
Prior to SS4943(g), excise taxes applied even if a private foundation did actually distribute all its annual surplus to charities. The underlying theory of the applicable law has changed in order to trace the tax effects of an exempt entity to its use.
The new rule is unlikely to affect private foundations that already exist. Perhaps the legal arrangements described in these requirements will be enough to prevent a family business creating and controlling a tax shelter to its profits. The provision allows a “social entrepreneur” (or other business owner with a mission) to provide support beyond his/her own life.
Newman’s case was different. SS4943(g), which relieved the private foundation of having to sell a majority stock of the company, should be considered prospectively as a valuable, if narrow, tax planning tool. This provision could also be used by partnerships, LLCs and certain other entities.
To achieve similar results, charitable-minded business owners might also consider a donor-advised trust, supporting organization, or charitable split-interest trust. The company owner may be able to deduct more Federal income tax if they give gifts to a charity than a private foundation.
1.Describe the history of excess business holdings tax. Did the provision have the purpose of being preemptive or to eliminate tax law abuses? Please be specific.
2.Is it possible to have a “separation between church and state” problem, so that charity and business do not come together? This is a desirable condition in today’s economy.