Contributing Author: William A Raabe
The 2018 Budget Act (signed into law on February 9, 2018) included an interesting exception to the long-established rule that a private foundation cannot own an operating for-profit business.
SWFT Volume 2 Chapter 15 Exhibit 15.4 points out that an excise tax applies when a private foundation owns more than 20% of the shares of an unrelated business. The tax on excess business holdings was created in 1969 to discourage business owners from transferring, during life or at death, an operating business to an exempt entity, thereby avoiding Federal income taxes on the profits. The annual §4943 tax is computed as 10% of the value of the portion of the business that the private foundation holds.
The new exception was supposed to be a part of the Tax Cuts and Jobs Act of 2017, but it was not included in the final bill. New §4943(g) is effective for tax years after 2017. It creates the term philanthropic business, which sounds like an oxymoron, in defining an entity for which the excise tax is waived.
What type of business enterprise can qualify for the §4943(g) waiver of the excess business holdings excise tax? Have your students think about the company that makes salad dressings and other food products under the brand name “Newman’s Own,” which they probably have seen and used. The actor Paul Newman created and led for many years a company that produced and distributed popular food products under this brand name. The company stock is held by the Newman’s Own Foundation, and all of the company profits have been distributed to charitable organizations, often promoting liberal causes. In this way, Newman could state that he made no personal profits from the products that bore his name and likeness.
Newman’s Own touts the high quality of its products, and one of its tag lines is “100% of Profits to Charity.” Newman is quoted as saying that the company “started as a joke and got out of control.” The diverse product line includes dressings, sauces, snacks, coffee, tea, wine, and pet food. Aggregate gifts to charity from the Foundation exceed half a billion dollars. Various financial and tax information about the Foundation is made available to the public.
The Foundation lobbied Congress for the amendment to the law for about a decade, roughly since the date of the actor’s death. The provision is known by some as the “Newman’s Own Exception,” because it was so closely identified with the business. Your students can use the Foundation as a prototype in describing the most important requirements for the waiver from the excise tax.
- The business operations are controlled by the private foundation through the latter’s 100% stock ownership.
- The private foundation received its shares by gift, bequest, or some other arrangement that was not a purchase.
- The board of the private foundation cannot have a majority of its members from the board/officers of the business, or from the company founder’s family.
- The business cannot have directors, officers, employees, or contractors from the company founder’s family. Nor can the business make loans to these parties.
- All of the company’s profits must be distributed to the private foundation. A reasonable reserve is allowed to account for business exigencies.
Prior to the enactment of §4943(g), the excise tax applied even if the private foundation actually did distribute all of its annual surplus to charities. Tracing the tax effects for an exempt entity to the use to which its funds are put is a change in the underlying theory of the applicable law.
Only a few existing private foundations are likely to be affected by the new rule, and perhaps the legal arrangements described in the requirements are enough to keep a family business from creating and controlling a tax shelter for its profits. The provision does allow a “social entrepreneur” or other business owner “with a mission” to extend support for that mission beyond his/her own life.
In Newman’s case, §4943(g) relieved the private foundation from having to divest itself of a majority of the company stock, but prospectively it should be considered as a valuable (if narrow) tax planning tool. The provision also could be used by partnerships, LLCs, and certain other entities.
Charitably inclined business owners alternatively might consider using a donor-advised fund, supporting organization, or a charitable split-interest trust to accomplish similar results. Gifts to a charity other than a private foundation may result in a larger Federal income tax deduction for the company owner.
Class Assignments
Tax Policy
1.Describe the history of the excess business holdings tax. Was the provision designed to be preemptive in nature, or to eliminate perceived abuses of the tax law? Be specific.
2.Is there a “separation of church and state” issue here, such that business and charity do not comingle? Is this a desirable condition in today’s economy and with today’s income tax rates?
Tax Research
1.How does §4943 define the net operating income of the business, i.e., the amount that it must distribute to the private foundation? Be specific.
2.Describe the §4943(g) requirements for the payment of the company’s profits to the private foundation. Give good citations.
3.For the latest tax year of the Newman’s Own Foundation, list total income, expenses, and distributions to charity. What are its total assets and liabilities? Who is its tax advisor? Who is the president of the foundation, and what is his/her total compensation?
SWFT CHAPTERS:
SWFT Comprehensive: Chapters 10 and 23
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