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Related Party Transactions – In General

To avoid the manipulation of tax consequences to which transactions between certain related[i] taxpayers may be susceptible, the IRS and the Courts generally require that such transactions be closely scrutinized to ensure that the form of the transaction reflects its underlying economic reality,[ii] and that the tax consequences arising therefrom are consistent with those arising from transactions between unrelated parties dealing at arm’s length with one another.[iii]

Similarly, the Code and the regulations promulgated thereunder have long recognized that a taxpayer who engages in certain transactions with another party should be denied a particular tax benefit that would otherwise be realized from the transaction if the taxpayer and the other party bear a certain relationship to one another and if the sought-after tax benefit is inconsistent with the economic consequences of the transaction. Continue Reading Related Party Transactions Converting Gain Into Ordinary Income – Be Careful Out There

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I am guessing that, later this week, many if not most of us will celebrate our uniquely American holiday, Thanksgiving Day. Hopefully, we will be fortunate enough to spend the day and share a meal with family and friends. With a bit of luck, politics will not find its way into our conversations and work will not intrude upon our time at home.

I’m willing to bet that turkey[i] will be on the menu – whether roasted or fried, whole, quartered, or segmented in some other way[ii] – alongside lasagna, moussaka, tandoori chicken, sauerbraten, rice and beans, perogy, goulash, couscous, kebab, borscht, empanada, chicken teriyaki, falafel, lamb, or whatever else our people brought with them when they came to this country.

As wonderful as the Thanksgiving holiday is, for historical reasons I have always associated it with federal taxes. Wait a minute, just hear me out.

Continue Reading Thanksgiving and. . . Taxes?

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The Mid-Terms

With 50 seats in the Senate, the Dems still control that Chamber. A win in the Georgia runoff, however, may lessen the burden for Majority Leader Schumer by, perhaps, neutralizing the significance of a certain member of his own party.[i]

Meanwhile, the GOP has claimed “control” of the House by a very thin margin,[ii] but the party’s leadership is already being challenged by its more conservative members.[iii]

On the other side of the aisle, moderate Dems in the House are certainly taking notice of how well the elections went for the “progressive” wing of their party.[iv]

Politics being what it is, would it surprise you if nothing happened in Congress for the next two years? Probably not. Continue Reading Thinking About Leaving New York? Don’t Forget to Check Your Federal Tax Return

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Priority Guidance Plan

Some folks eagerly await the release of a new album. Others camp outside of big box retailers to get the jump on holiday gifts. There are those who line up at box offices to purchase tickets for a concert that is months away. Then there are some who might as well be sitting on pins and needles after they’ve learned that their favorite tech company is about to announce the arrival of their latest “must-have”[i] gadget. Continue Reading Sale to IDGT, Death of Grantor, Basis Step-Up: Treasury’s Priority Guidance & the Dems’ Loss of the House

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The Key Person

The closely held corporation is often a fragile creature. Too often, its continued success and well-being are overly dependent upon the continued involvement of one individual – namely, the founder and principal owner of the corporation’s business.

This strong-willed individual may be responsible for the day-to-day management and operation of the business. Their relationships with the customers and vendors of the business, and with the business community generally, may represent a significant part of the corporation’s goodwill. Continue Reading Trusts, the Death of a Shareholder, and The S Corporation Election

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Say It Isn’t So

At different times over the course of the last thirty days or so, I have seen reports describing various plans to increase income taxes and/or wealth taxes on the “rich” that have either been endorsed or proposed by the likes of China’s President Xi Jinping, California’s Gov. Newsom, the Commonwealth of Massachusetts, Democratic Party leaders, and the European Central Bank, as a way to facilitate economic growth, redistribute wealth, and support vulnerable groups.[i]   Continue Reading LLC as S Corporation: Square Peg Meets Round Hole?

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Mid-Terms In Sight

On October 6, 2022, the President announced three changes in the Federal government’s policy toward cannabis:

  1. He pardoned all prior Federal offenses of simple possession of marijuana;[i]
  2. He urged governors to do the same with regard to state offenses;[ii] and
  3. He asked the Secretary of Health and Human Services (“HHS”) and the Attorney General to reconsider how marijuana is scheduled under Federal law.[iii]

The announcement came on the heels of increasing pressure from fellow Democrats who ran on a pro-marijuana platform in 2020 and who are facing mid-term elections next month with nothing to show for their efforts: Continue Reading Cannabis & the Mid-Terms: What Tax Policy?

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“Show Me the Money”[i]

Much has been written in recent months about how well the investment portfolios of private foundations have performed over the last several years. For example, a study conducted by the Council on Foundations reported that the average return on such investments in 2021 was 16.3 percent while the ten-year average annual return was 9.7 percent.[ii]

At the same time, much has also been written about how relatively little private foundations distribute to public charities. For example, according to the same above-referenced study, private foundations reported an average stated policy “spend rate” for 2021 of 5.1 percent; just over the Code’s 5 percent minimum distribution requirement.[iii]

DAFs

Lest one conclude on the basis of the foregoing spend rate that private foundations are fulfilling their responsibilities under the Code – after all, it appears they are complying with the minimum distribution requirement – consider that a not insignificant number of private foundations[iv] have been transferring funds not only to “publicly supported” organizations that engage directly in charitable activities[v] but also to grant-making donor-advised funds (DAF).

In brief, a DAF is an account established by an organization, classified as a public charity, to accept contributions from donors “in exchange” for (i) affording each donor the opportunity to identify the approved public charities to which the DAF will make a grant, and (ii) publicly recognizing that the grant originated from the amounts deposited with the DAF by the donor.

Today, approximately $160 billion is held by DAFs.[vi] However, the Code does not impose a minimum annual distribution requirement upon DAFs.[vii]

“Public” Response

As a result of (i) the impressive investment performance enjoyed by private foundations, generally, (ii) the fact that such foundations now hold more than $1.3 trillion in financial assets,[viii] and (iii) the fact that some foundations seem to be using DAFs as a means of further delaying the application of their wealth to charitable activities,[ix] many folks in the public sector have suggested that Congress amend the Code to compel private foundations and DAFs to make more significant distributions to charitable organizations that engage directly in charitable activities (as opposed to making grants) and that they do so on an accelerated basis.[x]

To better appreciate the reaction by many in the not-for-profit world to what may be perceived as the hesitation or even reluctance on the part of many private foundations to employ their quasi-public assets for the charitable public purposes to which they have been dedicated and on which their favored tax status is based, a brief discussion of the “tax economics” that drive such entities may be in order.

Behavior Modification

Many not-for-profit organizations are dependent, in no small part, upon the generosity of successful business owners or their private foundations.

These folks are motivated by a number of factors; for some, this generosity may be an expression of their gratitude to the community that has enabled them to thrive; for others, it may be a desire to share their good fortune with those in need; many may be driven by a desire for greater public recognition and the “incidental” benefits arising therefrom.

Whatever the motivation of these business owners, the tax laws have long played an important role in encouraging certain types of behavior relating to the contribution of property to a charity, and in discouraging certain activities that have the potential to harm a charitable organization, or to distract the organization from its charitable mission.[xi]

These tax-related “behavior modification” rules are intended to be most keenly felt by so-called “private foundations” and by those who control them.

Private Foundations

A private foundation is a kind of charitable organization that is not dependent upon the “general public” for financial support;[xii] rather, it is generally controlled by the individual who created the foundation[xiii] and funds its operations, whether directly or through their business.

In general, the foundation limits its charitable activities to making grants to those “public charities” selected by its founder and/or their family, in the amounts and at the times determined by these individuals.[xiv]

Thus, it may be presumed that the foundation’s behavior cannot be readily influenced by the public in most instances because the public is not in a position to tighten the strings on the proverbial purse from which the foundation is funded.

For that reason, the Code limits the tax benefits allowable to a foundation and its supporters,[xv] and also seeks to regulate certain activities in which they may – or may be tempted to – engage.

Reduced Income Tax Deduction

For example, the owner of a closely held business may donate shares of stock in the business (i.e., capital gain property) to their foundation, but the amount the owner may deduct as a charitable contribution for purposes of determining their income tax liability is limited to the owner’s adjusted basis in the donated stock[xvi] – not its fair market value at the time of the donation – and their deduction is capped at a lower percentage of adjusted gross income than would a similar contribution to a public charity.[xvii]

Self-Dealing

In order to prevent disqualified persons – basically, insiders – from improperly benefiting from their positions in or relationships to a private foundation, the Code prohibits or restricts certain transactions between such persons and the foundation.[xviii] For example, the sale of property between these two parties is generally prohibited.[xix]

However, a private foundation may pay compensation to a disqualified person for the performance of personal services which are reasonable and necessary to carry out the exempt purpose of the foundation, provided such compensation is not excessive.[xx] In making a determination of reasonableness, one must consider, among other things, whether the foundation is also providing a benefit to the disqualified person through an intermediary entity, such as a business corporation owned by the foundation.[xxi]

If a foundation violates the rule against self-dealing, it will be subject to an annual tax equal to ten percent of the amount involved in the self-dealing until the act of self-dealing is corrected.[xxii]

Minimum Distribution

As indicated above, a private foundation is required to distribute annually an amount equal to at least five percent of the fair market value of its assets, other than those assets that are used directly in carrying out the foundation’s exempt purpose.[xxiii]

This rule is aimed, in part, at preventing a business owner from contributing to a foundation, and a foundation from investing in, an interest in a closely held business that is illiquid and may not be able to distribute enough money to enable the foundation to satisfy its distribution obligation.

A foundation that violates this rule with respect to a taxable year faces a penalty equal to thirty percent of the distribution shortfall for such year.

Excess Business Holdings  

A more direct deterrent to a foundation’s ownership of a business that is engaged in a “business enterprise”[xxiv] is – or was?[xxv] – the rule against excess business holdings. In generally, a foundation is not permitted to hold more than twenty percent of the voting stock of a corporation, reduced by the percentage of the voting stock owned by all disqualified persons with respect to the foundation.[xxvi]

If a foundation violates this rule for any taxable year, it may be subject to an excise tax with respect to such year, and every subsequent year until the excess holding is eliminated, equal to ten percent of the fair market value of its holdings in the business in excess of the permitted amount.

This rule prevents a business owner from contributing stock in their corporation to a foundation, either during their life or at their death, and thereby avoiding or reducing federal estate and gift taxes while at the same time enabling their family to retain indirect control of the donated stock either through the corporation[xxvii] or through the foundation.

Depending upon the size of the gift or bequest of stock made to the foundation, the foundation may have five years, or perhaps as many as ten years, to dispose of the stock and thereby correct the proscribed investment and avoid imposition of the excise tax.[xxviii]

Unrelated Business Income

Finally, the Code imposes an income tax on the taxable income of a foundation for a taxable year that is derived from an unrelated trade or business of which the foundation is an owner.[xxix]

Where the foundation holds shares of stock in an S corporation, the foundation will be subject to the unrelated business income tax on its allocable share of the S corporation’s taxable income.[xxx]

If a foundation is a member of an LLC that is treated as a partnership for tax purposes, the foundation’s share of the LLC’s income will be taxed as unrelated business income to the extent such income is derived from an unrelated trade or business conducted by the LLC.[xxxi]

If all of the interests in an LLC are held by a foundation, the LLC will become a disregarded entity for tax purposes[xxxii] and the foundation will be treated as engaging directly in the LLC’s business.[xxxiii]

However, dividends received by a foundation from a C corporation, even one that is wholly owned by the foundation, are generally not treated as unrelated business income,[xxxiv] though the 1.39 percent excise tax on the foundation’s net investment income will continue to apply to such dividends.[xxxv]

Newman’s Own Foundation

An illustration of how some of the foregoing rules are applied may be found in the case of Newman’s Own Foundation (the “Foundation”), which recently became the subject of a lawsuit brought in August of this year by two of Paul Newman’s daughters.[xxxvi] A brief history of the Foundation, as gleaned from tax returns and state filings, may be helpful.

The Business[xxxvii]

Newman’s Own, Inc. was incorporated in 1982. Its mission: to produce and distribute various healthful food products (it started with a salad dressing),[xxxviii]  and to distribute all the profits therefrom to various charities.

At some point, the corporation elected to be treated as an S corporation for tax purposes.[xxxix]

Not only did the S election allow Newman’s Own to avoid a corporate-level income tax, but it also allowed the charitable contributions made by the corporation to flow through to its individual shareholders,[xl] thereby enabling them to claim charitable deductions for purposes of determining their personal income tax liability.

What’s more, whereas a C corporation’s charitable contribution deductions for any taxable year would be limited to 10 percent of the corporation’s taxable income,[xli] the cap for cash contributions allocated to individual shareholders of an S corporation would generally be limited to 50% of their contribution base for the year.[xlii]

The Foundation

The Foundation was incorporated in 1998 as a non-stock[xliii] corporation under Delaware law. It was not recognized as a tax-exempt organization until 2004 and filed its initial federal tax return for its fiscal year ended August 31, 2005.

In addition, the Foundation appears not to have been funded until that fiscal year, during which Mr. Newman contributed a partnership interest with a reported fair market value of $78.6 million.[xliv] (Query whether this was a 99.9 percent interest in No Limit LLC. See below.) The Foundation did not report any excess business holdings or unrelated business income during that year. Its income was attributed almost entirely to its K-1 income from the partnership.

From its inception until just before his death, Mr. Newman was the sole member of the Foundation.[xlv]

Before Mr. Newman’s death in September 2008, and through the fiscal year ended August 31, 2009,[xlvi] the Foundation reported that it did not own any “controlled entity,” it did not report unrelated business income, and it reported that it did not hold more than a 2 percent direct or indirect interest in any business enterprise during the year; in other words, it did not have excess business holdings.

The Foundation then changed its taxable year to the calendar year – “to conform to the year end of other entities within its corporate group” – and filed a short period return for the taxable year beginning September 1, 2009 and ending December 31, 2009.[xlvii]

For this “second” 2009 return, the Foundation reported that it owned three controlled entities, including 100 percent of Newman’s Own and 99.9 percent of No Limit LLC, and that it had unrelated business income attributable entirely to its share of S corporation income from Newman’s Own, which it reported on IRS Form 990-T for the short year.

Thus, it appears that following Mr. Newman’s death all the outstanding shares of stock of Newman’s Own passed to the Foundation.

As of January 1, 2010, Newman’s Own became a C corporation; its election to be treated as an S corporation was voluntarily revoked.[xlviii] Ostensibly, the likeliest reason for this change in tax status was the treatment of the corporation’s profits as taxable unrelated business income in the hands of the Foundation, whereas the receipt of dividends from a C corporation would not have been treated as such income.[xlix]

During 2010, the Foundation received a distribution of previously taxed S corporation income from Newman’s Own. In 2011, it received a dividend from the corporation.[l]

Interestingly, beginning with 2012 and continuing at least through 2019,[li] Newman’s Own did not distribute any dividends to the Foundation.

The returns filed from 2009 through 2012 did not describe the Foundation’s interest in Newman’s Own as an excess business holding, whereas it was described as such from 2013 through 2017.

Query whether it should have been. Following what appears to have been a testamentary transfer of ownership of Newman’s Own to the Foundation, the latter would have had five years to eliminate its excess business holdings to avoid imposition of the excise tax.[lii]

If five years (ending in 2013) was insufficient, the Foundation could have requested – and probably did request – that the IRS give it an additional five years (ending in 2018) to dispose of the stock.[liii] Although the “public record” is unclear as to whether the Foundation was granted an additional 5 years by the IRS for purposes of disposing of the stock, a private letter ruling issued in April of 2013 seems to fit the bill.[liv]

BBA of 2018

Just as the Foundation approached what would have been the end of its five-year extension for disposing of its Newman’s Own stock, Congress passed and, on February 9, 2018, the President signed into law, the Bipartisan Budget Act of 2018 (the “Act”), effective for taxable years beginning after December 31, 2017.[lv]

According to the accompanying committee report,[lvi] in recent years, a new type of philanthropy had combined “private sector entrepreneurship” with charitable giving; for example, through the donation of a private company’s entire after-tax profits to charity.[lvii]  The report went on to state that it was appropriate “to encourage this form of philanthropy by eliminating certain legal impediments to its use, while also ensuring that private individuals cannot improperly benefit from charitable dollars.”

The Act amended the Code[lviii] to permit a business owner to gift or bequeath an entire business to a private foundation, provided that the after-tax profits of the business will be paid to the foundation and certain other requirements are satisfied.

The new provision created an exception to the excess business holdings rules for certain “philanthropic business holdings.” Specifically, the tax on excess business holdings will not apply with respect to the holdings of a foundation in any business enterprise that, for the taxable year, satisfies:

  • the “exclusive ownership” requirements;
  • the “all profits to charity” requirement; and
  • the “independent operation” requirements.

Exclusive Ownership

The exclusive ownership requirements are satisfied for a taxable year if:

  • all voting ownership interests in the business enterprise[lix]are held by the foundation at all times during the taxable year; and
  • all the foundation’s ownership interests in the business enterprise were acquired by the foundation as gifts during the life of the donor, or as testamentary transfers at the donor’s demise, under the terms of the donor’s will or trust, as the case may be.[lx]

All Profits to Charity

The “all profits to charity” requirement is satisfied if the business enterprise, not later than 120 days after the close of the taxable year, distributes an amount equal to its net operating income for such taxable year to the foundation.[lxi]

For this purpose, the net operating income of any business enterprise for any taxable year is an amount equal to the gross income of the business enterprise for the taxable year,[lxii] reduced by the sum of: (1) the deductions allowed for the taxable year that are directly connected with the production of the income; (2) the federal income tax imposed on the business enterprise for the taxable year;[lxiii] and (3) an amount for a reasonable reserve[lxiv] for working capital and other business needs of the business enterprise.

Independent Operation

The independent operation requirements are met if, at all times during the taxable year, the following three requirements are satisfied:

  • First, no substantial contributor to the private foundation, or a family member 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[lxv]).
  • Second, at least a majority of the board of directors of the foundation are individuals who are not (1) directors or officers of the business enterprise, nor (2) members of the family of a substantial contributor to the foundation.
  • Third, there is no loan outstanding from the business enterprise to a substantial contributor to the foundation or a family member of such contributor.

Royalties

Having assured itself of not being subject to the excise tax on excess business holdings, has the Foundation caused Newman’s Own to resume making dividend distributions?

If 2018 and 2019 are any indication, no.

Indeed, for those years and for every tax year since its incorporation in 2005, the Foundation’s chief source of revenue has been from the distribution of royalty income by an LLC that is 99.9% owned by the Foundation: “No Limit LLC.”[lxvi]

Based upon information set forth in the Complaint, the goal was for the Foundation – more accurately, No Limit LLC (99.9 percent owned by the Foundation) – to license the use of Mr. Newman’s name, image, and likeness to Newman’s Own (a for profit, taxable entity, 100 percent owned by the Foundation) in exchange for royalty payments. Newman’s Own would be able to deduct the royalty payments in determining its taxable income[lxvii] – something it could not do with dividend distributions – thereby reducing its income tax liability, while the Foundation would not be taxed upon its receipt of such royalty payments.[lxviii]

Interestingly, it appears that no portion of the royalties was treated as unrelated business income from an entity controlled by the Foundation. Specifically, the Code requires that royalties received from such a controlled entity be treated as taxable income to the extent they exceed an arm’s length rate. Thus, it may be inferred that the royalty is determined using an arm’s length standard.[lxix]

Qualifying Distributions

Interestingly, the Foundation made two to three grants to DAFs in 2018 and 2019, amounting to approximately 8 percent of its total grants in each year.[lxx] In no prior years were such distributions made.

Query the reason for the change. The statement attached to the 990-PF explains that the DAF’s “funds are generally distributed within 12 months or less”; in other words, it won’t take long for the Foundation to direct their disposition to operating charities.

What Does It Mean?

Over the years, I’ve had many business owners ask me whether they could operate their business as a tax-exempt entity. Of course, they wanted to follow Mr. Newman’s example, not realizing that Newman’s Own was not organized as a charity but as a for profit enterprise whose owner had decided to give away its profit because he didn’t need it. Once these other business owners understood the Newman’s Own model, they quickly lost interest.

That said, as a result of the 2018 amendment to the excess business holding rules, a private foundation may now be able to own all of the issued and outstanding stock of a corporation (its subsidiary) that operates an active business, provided the various requirements described above are satisfied.

Depending upon how well the business does, a foundation-parent may find itself with plenty of resources to use in making charitable grants, or it may find itself in a less than enviable position, and strapped for cash, if the business does poorly.[lxxi]

Which brings us back to the questions touched upon earlier: should foundations be making larger charitable grants, and should the minimum annual distribution requirement be increased?

The Foundation’s tax returns indicate that it has been making annual grants which, in the aggregate, are always well in excess of – sometimes between two and three times – its “distributable amount”[lxxii] for the year. Based upon the information in the Complaint, it also appears that the Foundation has been trying to maximize the amount of funds available to it for its grant-making activities.

I have no idea whether the Complaint has legs or not – the Court will make that determination. However, I do believe that Mr. Newman’s influence is reflected in what appears to be the Foundation’s policy of making grants significantly beyond the minimum required under the Code, though this is not necessarily the same as making grants that are commensurate to the Foundation’s financial ability or resources.[lxxiii]

Unfortunately, not every private foundation had a Mr. Newman to provide an example or to set expectations.

That’s where the Code should step in to provide the necessary incentives and encouragement.

 

[i] Rod Tidwell (played by Cuba Gooding Jr.): Jerry, you got to yell!

Jerry Maguire (played by Tom Cruise): [screaming] Show me the money! Show me the money!

[ii] For example, https://www.commonfund.org/research-center/press-releases/council-on-foundations-commonfund-study-of-foundations-released.

[iii] Id. Under the minimum distribution requirement of IRC Sec. 4942, a private foundation generally must distribute on an annual basis an amount equal to at least 5% of the fair market value of the foundation’s investment assets for the year in question.

[iv] Including some that may be described as household names, as we will see.

[v] So-called “qualifying distributions.” These recipients include health-related, scientific, eleemosynary, educational, religious, cultural, environmental, and many other types of non-grant-making not-for-profit organizations. I’m sorely tempted to add “ostensibly” when describing the “not-for-profit” status of many universities.

[vi] https://nonprofitquarterly.org/new-data-tells-us-where-donor-advised-fund-dollars-go-and-dont-go/.

[vii] That said, some DAFs themselves require minimum distributions from the accounts established by donors.

[viii] As of the second quarter of 2022. https://fred.stlouisfed.org/series/BOGZ1FL164090015Q.

[ix] Or stated differently, deferring their relinquishment of control over the disposition of their minimum annual distribution. Query why? To what end?

[x] See, for example, https://acceleratecharitablegiving.org/reforms/#private-foundations; https://philanthropynewsdigest.org/news/philanthropy-divided-over-legislation-to-accelerate-daf-grants.

[xi] See the General Explanation of the Tax Reform Act of 1969, prepared by the Staff of the Joint Committee on Internal Revenue Taxation, December 3, 1970 (Joint Committee Explanation), for a good review.

[xii] Compare the public charity, the revenues of which come, by and large, from the general public (as contributions or as fees for services), including other charities and government. IRC Sec. 509(a).

[xiii] At least so long as they are alive and competent.

[xiv] Rather than providing any charitable service, itself.

[xv] Our focus here is on the foundation itself and less on the benefits realized by its donor(s), though these should not be overlooked.

[xvi] IRC Sec. 170(e). In part, the reduced tax benefit for the donor reflects the illiquid nature of an interest in a closely held business – the foundation cannot simply sell it on a public market. The Code also seeks to prevent the donor-business owner from receiving a more favorable tax benefit without giving up de facto control over the donated business interest.

[xvii] IRC Sec. 170(b)(1)(B) and Sec. 170(b)(1)(D).

[xviii] IRC Sec. 4941.

[xix] IRC Sec. 4941(d)(1)(A).

[xx] IRC Sec. 4941(d)(2)(E); Reg. Sec. 53.4941(d)-3(c).

[xxi] Consider a foundation insider who is also employed by a business entity in which the foundation is the single largest shareholder.

[xxii] In general, a 5% tax is also imposed on foundation managers.

[xxiii] IRC Sec. 4942.

[xxiv] IRC Sec. 4943(d)(3).

[xxv] See the discussion of the 2018 legislation later.

[xxvi] IRC Sec. 4943(c)(2)(A). A foundation is not treated as having excess business holdings in a business in which it owns not more than 2% of the voting stock (profits interest) and not more than 2% in value of all the outstanding shares of stock (profits interests and capital interests). IRC Sec. 4943(c)(2)(C). There are no permitted holdings in the case of a proprietorship.

[xxvii] By determining whether to make distributions, including when and how much to distribute.

[xxviii] IRC Sec. 4943(c)(6) and (7). During this period, the foundation’s interest in the business is treated as held by a disqualified person.

[xxix] IRC Sec. 511.

[xxx] IRC Sec. 512(e). The gain from the sale of the S corporation stock will also be taxable to the foundation.

[xxxi] IRC Sec. 512(c).

[xxxii] Reg. Sec. 301.7701-3.

[xxxiii] Obviously, this will raise unrelated business income tax issues, but it may also jeopardize the foundation’s tax-exempt status if the business is substantial relative to the foundation’s charitable activities.

[xxxiv] IRC Sec. 512(b).

[xxxv] IRC Sec. 4940.

[xxxvi] The complaint was filed against the Foundation on August 23, 2022 in the Superior Court, J.D. of Stamford-Norwalk (the “Complaint”).

[xxxvii] https://www.company-histories.com/Newmans-Own-Inc-Company-History.html.

[xxxviii] The manufacturing of these products is outsourced. For example, Ben & Jerry’s manufactures the ice cream.

[xxxix] See the Foundation’s 990-PF for 2010.

[xl] It appears Mr. Newman (whether directly or through his Living Trust) was the only shareholder.

[xli] IRC Sec. 170(b)(2)(A).

[xlii] Basically, adjusted gross income without regard to NOL carrybacks. IRC Sec. 170(b)(1)(A) and (H).

[xliii] Not-for-profit.

[xliv] See the 2004 IRS Form 990-PF, https://projects.propublica.org/nonprofits/display_990/61606588/2006_08_PF%2F06-1606588_990PF_200508.

[xlv] According to the Complaint, Mr. Newman appointed two additional members only two months before his death.

[xlvi] The Foundation’s fiscal year in which he died.

[xlvii] See Statement 8 to the Foundation’s 990-PF for the YE December 31, 2009.

[xlviii] IRC Sec. 1362(d)(1).

[xlix] In exchange for allowing Sec. 501(c)(3) organizations to hold shares of S corporation stock, Congress required that the income allocated to the exempt organization be treated as unrelated business income. IRC Sec. 1361(c)(6), Sec. 1366, Sec. 512(e), and 512(b)(1).

[l] IRC Sec. 1371(e) and Sec. 1377(b).

[li] The latest year for which the Foundation’s 990-PF is available.

[lii] IRC 4943(c)(6).

[liii] IRC 4943(c)(7).

A request for the extension of the period for disposition should be submitted as a private letter ruling request to the Associate Chief Counsel (Employee Benefits, Exempt Organizations, and Employment Taxes).

[liv] PLR 201328034.

The PLR states:

“You acquired *** percent of Corporation stock as a donation from your Founder after his death. You have excess business holdings in Corporation under § 4943(c)(1). Your initial five-year period for disposing of these excess business holdings will end on Date 1.

“During the initial five-year period for disposing of excess business holdings under § 4943(c)(6), you have created a more formal management and governance structure for Corporation, and taken steps to unify the Brand with respect to ***. Your managers have consulted with advisors, valuation specialist and legal counsel to discuss the various disposition options available to you.

“You represent that, because of the size, value, nature, and complexity of this business holding, you have, despite your best efforts, been unable to complete the sale of Corporation stock within the prescribed five-year period except at a price substantially below fair market value. You represent that you will be better able to determine and realize the full fair market value of your interest in Corporation after the expiration of the initial five-year period.

“Your directors have established a plan of disposition that includes either selling your Corporation stock to an unaffiliated third party or donating Corporation shares to one or more charitable organizations. Your directors expect that they can dispose of the Corporation stock no later than Date 2. You submitted the plan to your appropriate state Attorney General and are waiting for a response.”

[lv] P.L. 115-123.

[lvi] S. Rept. 114-20.

[lvii] Hmm. Sounds familiar. Hardly new as to Newman’s Own, though.

[lviii] IRC Sec. 4943(g).

[lix] A “business enterprise” does not include a business that is functionally related to the foundation’s exempt activities, or a trade or business at least 95% of the gross income of which is derived from “passive sources.”

Might some donors with foresight be tempted to split up their business so as to satisfy the exclusive ownership interest as to those segments of the business intended for the foundation?

[lx] It appears that the donor cannot transfer some of the equity as a lifetime gift and the balance at their death. Presumably, the business may redeem a portion of the donor’s equity from their estate (thereby providing the estate with liquidity to pay taxes or make other testamentary transfers) and passing the remaining equity to a foundation.

[lxi] Query how to reconcile the absence of dividends received from Newman’s Own on the Foundation’s 990-PF with this requirement.

[lxii] Including any investment income.

[lxiii] Of course, the business remains subject to federal income tax. Moreover, if the foundation were to liquidate the business, such liquidation would be a taxable event under regulations issued under IRC Sec. 337.

[lxiv] Query what constitutes a “reasonable” reserve.

[lxv] Query whether, in the case of a N.Y. membership corporation, this would cover a member of the foundation.

[lxvi] Note that an activity that generates royalties is not considered a “business enterprise” for purpose of the excess holding rules. IRC Sec. 4943(d)(3)(B).

[lxvii] IRC Sec. 162.

[lxviii] IRC Sec. 512(b)(2).

[lxix] IRC Sec. 512(b)(13)(E).

[lxx] Among the largest grants the Foundation made to any single charity.

[lxxi] Query whether the jeopardy investment rules of IRC Sec. 4944 may be implicated.

[lxxii] IRC Sec. 4942(d).

[lxxiii] I don’t recall having ever seen such a proposal in Congress.

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Constructive Transfers

It is axiomatic that the tax treatment of interactions between a closely held business and its owners will generally be subject to heightened scrutiny by the IRS, and that the labels attached to such interactions by the parties will have limited significance unless they are supported by objective evidence.

Benefit to the Shareholder

Thus, arrangements that purport to provide for the payment of compensation, rent, interest, royalties, etc., by a corporation to a shareholder – and which generally would be deductible by the corporation – may be examined by the IRS and possibly re-characterized to comport with their true nature.

Similarly with respect to a corporation’s satisfaction of an expense or other obligation that, on its face, is owing from a shareholder to a third party but for which the corporation claims a tax deduction by characterizing the amount as an expense incurred by or on behalf of the business. Continue Reading Business Expenses Paid by Shareholder, But Whose Deduction Is It?

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Sibling Rivalry

You have probably encountered family-owned corporations in which the founder’s offspring are involved in the business to varying degrees. They may even own some equity, typically having received such equity as gifts from their parents.[i] These situations often evolve in a way that they present challenging succession planning issues for the family and its business.

Let’s assume that two siblings are active participants in the family-owned business. Each aspires to lead the corporation after their parents have retired. At some point, their competing goals, divergent management styles, or different personalities may generate enough friction between the siblings, and within the corporation, so as to jeopardize the continued well-being of the business.[ii]

Continue Reading Dividing the Multi-Family Corporation