A little-explored aspect of The Bipartisan Budget Act, signed into law on February 9, 2018, may be a boon to individuals who want to use stock in their family businesses to fund private foundations.
Under previous law, private foundations were restricted in their ownership of any business enterprise; excess amounts were subject to significant taxation. Now, an exception (created by the Bipartisan Budget Act) eliminates the tax on those private foundations with excess business holdings as long as certain conditions are met.
What is a private foundation?
A private foundation is an independent legal entity set up solely for charitable purposes. Unlike a public charity, which relies on public fundraising to support its activities, the funding for a private foundation typically comes from a single individual, a family, or a corporation, which receives a tax deduction for donations. Typically, those who set up the foundation manage it as well. The majority of private foundations conduct their charitable activities by granting money to other charities – schools, hospitals, churches, museums, food pantries, you name it. Private foundations provide an effective means for individuals, families, and companies to give money away.
What were the restrictions on private foundations?
Historically, a number of very strict rules were in place that limited the activities and investments of private foundations. This is because private foundations, unlike public charities, don’t face public scrutiny. Stricter codes ensured appropriate standards of conduct were met.
The prohibition against excess business holdings was just one example of these stricter rules. The rule stated that a private foundation in combination with a broad category of related parties known as ‘disqualified persons’ could not own more than 20% of a for-profit business enterprise. This was a limitation on a number of philanthropically inclined people, particularly those who own private businesses because, with their wealth tied up in a private company, they couldn’t give assets to the private foundation without the foundation being required to sell, or at least divest, a big portion of the business. It also limited estate giving. Many people, at the time of their death, wish to give 100% of their company to a private foundation. Under the old law, the foundation would have been required to sell at least 80% of that company within 5 years.
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% of the voting stock. All the profits of the business have to go to the private foundation which then will distribute the funds to charity. 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. Lastly, there can’t be any loan outstanding from the company to any contributors to the foundation or any family members.
What’s the impact?
The provision provides a wide opening for charitably inclined business owners. It also clears a hurdle for private-foundations to fully own a for-profit business.
Take, for example, the Newman’s Own Foundation. The business (you know it as the salad dressing and natural foods line) 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% of the business. They did receive 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 have been 200% of the value of the business. They would have been forced to close.
If, like many of our clients, you own a family business and are interested in establishing a foundation, now may be the time. Reach out to your BGW tax professional for guidance. We’re here for you.