Private Foundations — Excess Business Holdings (Portfolio 473)

Tax Management Portfolio, Private Foundations — Excess Business Holdings, No. 473, explains the application and operation of §4943 of the Internal Revenue Code, which imposes an excise tax on the excess business holdings of private foundations and certain supporting organizations.

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Tax Management Portfolio, Private Foundations — Excess Business Holdings, No. 473, explains the application and operation of §4943 of the Internal Revenue Code, which imposes an excise tax on the excess business holdings of private foundations and certain supporting organizations. The portfolio discusses the special rules for the required divestiture of a private foundation's excess business holdings held on May 26, 1969, the effective date of §4943. These rules permit a private foundation a phased divestiture period of up to 20 years to dispose of its pre-May 27, 1969, excess business holdings until they have been reduced to the permitted level.
The portfolio also explains the exception to the excess business holdings rules for functionally related businesses, as well as the complex rules governing the acquisition of excess business holdings after May 26, 1969. There is a discussion of how the holdings of disqualified persons with respect to the private foundation can have an effect on the calculation of the private foundation's own holdings. Finally, there is a discussion of how the 10% initial tax (as increased from 5% by the Pension Protection Act of 2006) and 200% additional tax are calculated and imposed and the administrative and judicial remedies available to the foundation. The discussions are illustrated by comprehensive examples throughout the portfolio. It is important to note that the Pension Protection Act of 2006, P.L. 109-280, made substantive changes to §4943. In addition, certain provisions of the Tax Relief and Health Care Act of 2006, P.L. 109-432, indirectly affect some of the regulations associated with §4943. This Portfolio reflects changes to §4943 and its accompanying regulations made by the Pension Protection Act of 2006 and the Tax Relief and Health Care Act of 2006. To date, in most instances new regulations to §4943 have not yet been promulgated to reflect the provisions of this legislation.
The Worksheets contain, inter alia, the legislative history of §4943, which was added to the Code by §101(b) of the Tax Reform Act of 1969.
This portfolio may be cited as Horwood and Wiktor, 473 T.M., Private Foundations — Excess Business Holdings.

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Mr. Horwood is with the law firm of Horwood Marcus & Berk Chtd. He has written extensively in legal journals and other trade publications, and has lectured throughout the United States on various business, estate, and tax-related issues. Mr. Horwood is a Fellow of the American College of Trust and Estate Counsel (ACTEC) and is associated with numerous professional organizations, including the advisory boards of Tax Management, The Journal of Taxation of Investments, The Art Institute of Chicago, The Field Museum, and the Chicago Estate Planning Council. He is a graduate of Colgate University and the University of Pennsylvania Law School. He also holds an M.B.A. in Financial Management from American University and an LL.M. in Taxation from George Washington University. Mr. Horwood was formerly with the National Office of the Internal Revenue Service in Washington, D.C.

Mr. Wiktor is with the law firm of Horwood Marcus & Berk Chtd. and concentrates on all facets of wealth and charitable planning. His practice involves estate planning, including taxation, trust and estate administration, asset protection, business succession planning and charitable gift giving techniques. John has also represented individuals and charitable organizations as beneficiaries in will and trust disputes, individual and corporate fiduciaries in will and trust construction matters and individuals in contested guardianship proceedings. He has given numerous lectures on several wealth planning techniques and charitable gift agreements. John received his J.D. with honors, from the Loyola University Chicago, School of Law, and his B.A. in History from the University of Michigan.

Christopher G. Stoneman, B.A. (Law) Cambridge University (1949); LL.B., University of Virginia (1957); M.A., New York University (1989); member, American Bar Association, New York and Vermont Bars; former Fellow, American College of Trusts and Estates Counsel; author of several other Portfolios in the estate planning field.


Portfolio Description


Technical Advisors


Detailed Analysis

I. Introduction

A. Background

B. General Rule

C. Effective Date

II. Threshold Requirements

A. General Rule Summarized

B. Entities Subject to the Tax

1. Private Foundations

2. Section 4947 Trusts

a. Section 4947(a)(1) Charitable Trusts

b. Section 4947(a)(2) Split-Interest Trusts

(1) In General

(2) Pre-May 27, 1969 Transfers

(3) Section 4947(b)(3) Exception to § 4947(a)(2)

3. Certain Estates and Trusts

a. Estates

b. Trusts

C. Holdings in a "Business Enterprise"

1. Business Enterprise's Degree of Activity

a. At Least 95% of Gross Income Must Be Derived from Passive Sources

b. 95% Test

c. Private Letter Rulings

d. Passive Interest Subsequently Becomes an Interest in a Business Enterprise

2. Functionally Related Business

a. Definition

b. Private Letter Rulings

3. Program-Related Investments

a. Definition

b. Private Letter Rulings

c. Program-Related Activities Cease

D. Quantum of "Business Holdings"

1. In General

2. Constructive Ownership Rules

a. In General

(1) No "Upstream" Attribution

(2) No "Family" Attribution

(3) Double Attribution

(4) Powers of Appointment

(5) Warrants and Other Options

b. Determination of Extent of Constructive Ownership

(1) Shareholders' Constructive Ownership from Corporation

(a) For Purposes of § 4943(c)(2)

(b) For Purposes of § 4943(c)(4), (5)

(c) Constructive Ownership of Nonvoting Stock for Purposes of Applying § 4943(c)(2)(A)

(2) Shareholders', Partners', or Beneficiaries' Constructive Ownership from a Disqualified Person

(3) Beneficiaries' Constructive Ownership from an Estate or Trust

(a) In General

(b) Post-May 26, 1969 Transfers to Split-Interest Trusts

(c) Pre-May 27, 1969 Transfers to Split-Interest Trusts

(d) Employee Benefit Trusts

(e) Revocable Trusts

(f) "Beneficiary" Defined

(4) No Attribution from Corporation Actively Engaged in a Trade or Business

(a) In General

(b) Active Trade or Business

(c) Corporation Involved in a Prohibited Transaction

(d) Affiliated Group

(5) Partnership

(6) Stock Held by a Fiduciary or Pledgee

E. Determination of Excess Business Holdings

1. Introduction

2. "Excess Business Holdings" Defined

3. "Permitted Holdings" Defined

a. Permitted Holdings in a Corporate Business

(1) General Rule

(a) Voting Stock

(b) Nonvoting Stock

(i) General Definition

(ii) Stock with Contingent Voting Rights, and Convertible Nonvoting Stock

(c) Example

(2) Where One or More Non-Disqualified Persons Have Effective Control of Enterprise

(3) 2% De Minimis Rule

b. Permitted Holdings in a Noncorporate Business

(1) Partnerships and Joint Ventures

(2) Sole Proprietorships

(3) Trusts and Other Unincorporated Businesses

(a) In General

(b) Trusts

(c) Other Unincorporated Businesses

F. Application to Donor Advised Funds and Supporting Organizations

1. Introduction

2. Donor Advised Funds

3. Supporting Organizations

III. Special Rules for May 26, 1969 Holdings and Certain Later Acquisitions

A. Introduction

1. Present Holdings

2. Holdings Acquired by Trust or Will

3. Post-May 26, 1969 Gifts and Bequests

4. Large Gifts and Bequests

B. Detailed Discussion

1. Present Holdings

a. In General

b. Detailed Analysis

(1) Section 4943(c)(4)(A)

(a) Basic Rule - § 4943(c)(4)(A)(i)

(b) Downward Ratchet Rule - § 4943(c)(4)(A)(ii)

(i) In General

(ii) Mechanics of the Downward Ratchet Rule

(iii) De Minimis Net Decreases in May 26, 1969, Holdings Disregarded

(iv) Effect of § 4943(c)(4)(A)(iii) and (iv)

(v) Changes in Relative Fair Market Values of Shares of Different Classes

(vi) Special Rules

(A) Change of Foundation Managers

(B) Change of Private Foundation's Status Under § 507

(2) Section 4943(c)(4)(B): Treatment of Excess Business Holdings as Being Held by Disqualified Persons

(a) Introduction

(i) Generally

(ii) Interaction of § 4943(c)(4), (5), and (6)

(iii) Private Letter Rulings

(iv) Technical Advice Memorandums.

(b) "Present Holdings" in General

(c) First-Phase Holding Periods

(i) Generally

(A) 20-Year First Phase

(B) 15-Year First Phase

(C) 10-Year First Phase

(D) Historical Note - § 4943(c)(4)(E) Election

(ii) Examples

(3) Section 4943(c)(4)(C): Suspension of First-Phase Period

(4) Section 4943(c)(4)(D): Second-Phase Holding Period

(a) In General

(b) Determination of Second Phase Permitted Holdings

(c) 25% Limit on Foundation's Holdings

(i) In General

(ii) Inapplicability During Second Phase

(5) Third-Phase Holding Period

(6) Special Rules

(a) All Holdings Permitted Under § 4943(c)(2)

(b) Changes Occur in Relative Values of Stock of Different Classes

(c) Certain Foundations Incorporated Before January 1, 1951

(7) Special Rules for Readjustments Involving Grandfathered Holdings To Which § 4943(c)(4) or (5) Applies

2. Holdings Acquired Under Pre-May 27, 1969, Trusts, Wills, Etc.

a. In General

b. Scope of § 4943(c)(5)

c. After-Acquired Interests

d. Certain Revocable Trusts Treated as the Equivalent of Wills

e. Post-May 26, 1969, Modifications of Pre-May 27, 1969, Wills

f. Determination of Holding Periods

g. Constructive Ownership Before Distribution

h. Determination of Permitted Holdings

(1) In General

(2) Separate Phases for Different § 4943(c)(5) Interests

(a) Generally

(b) Examples

3. Special Rules for Readjustments Involving Grandfathered Holdings

a. In General

(1) Readjustments

(2) No Exchange Necessary

b. Exceptions and Limitations

(1) Limitation on Increases in Percentage of Voting Stock

(2) Limitation on Increases in Percentage of Value

(3) Increases in Percentage of Both Voting Stock and Value

(4) Exception for Prohibited Transactions

(5) Voting and Value Levels

(6) Determination of Phases

(a) In General

(b) Transitional Rule

(7) Plan to Dispose of Excess Business Holdings

c. Application to Unincorporated Business Enterprise

d. Examples

4. Holdings Acquired Under Post-May 26, 1969, Trusts, Etc.

a. Generally

(1) Where Private Foundation Has No Excess Business Holdings

(2) Where Private Foundation Already Has Excess Business Holdings

(3) Non-Purchase Acquisitions

(a) Examples

(b) Private Letter Rulings

b. Special Rules for Acquisitions by Will or Trust

(1) In General

(2) After-Acquired Property

c. Acquisition by Disqualified Person

d. Special Rule for § 4943(c)(5) Interests Acquired from a Non-Disqualified Person

e. Exceptions to the Application of § 4943(c)(6)

(1) Certain Inter-Foundation Transfers

(2) Increases Due to Ongoing Purchase Plan

(3) Purchases by Certain Entities Controlled by Disqualified Persons

(4) Substitution of Interest in Specific Property for Other Property

f. Readjustments and Distributions

(1) Generally

(2) Exceptions to General Rule

(3) Section 4943(c)(6) Holdings

(4) Redemption by a Corporation That Is a Disqualified Person

(5) One Percent Rule for Redemptions

(6) Examples

g. Constructive Holdings

5. Extension of Transition Period for Large Gifts or Bequests - § 4943(c)(7)

a. Effective Date

b. In General

c. Private Letter Rulings

IV. Computation of Initial Tax and Additional Tax

A. Introduction

B. Initial Tax

1. In General

2. Elements for Imposition

a. Excess Business Holdings

b. Of a Private Foundation

c. In a Business Enterprise

d. During Any Taxable Year Ending During the Taxable Period

(1) In General

(2) Special Rules

(a) Elimination of Excess Within 90 Days

(b) Waiver of Restrictions on Assessment; Payment of Deficiency

(c) Ninety-Day Suspension of Taxable Period

(3) IRS Position

e. Determination of Value as Basis for Imposition of Initial Tax

(1) In General

(2) Value Defined

(3) Application of Rule

(4) Examples

3. Ninety-Day Escape Hatch

a. In General

(1) Private Foundation's Acquisition of Excess Business Holdings Other Than by Purchase

(2) Disqualified Person's Acquisition of Excess Business Holdings

b. Extension of 90-Day Period

c. Material Restrictions on Transferee's Use of the Business Interest

d. Foundation Knowledge of Disqualified Persons' Acquisitions

4. Abatement of First-Tier Tax Under § 4962

a. In General

b. Meaning of "Correct"

c. Meaning of "Correction Period"

C. Additional Tax

1. In General

2. Elements for Imposition

a. Excess Business Holdings

b. Of a Private Foundation

c. In a Business Enterprise

d. With Respect To Which Holdings an Initial Tax Has Been Imposed

e. Which Holdings Are Still Held by the Private Foundation at End of Taxable Period

f. Determination of Basis for Imposition of Additional Tax

3. Section 4961 Abatement of Second-Tier Tax Where Timely Correction Is Made

a. In General

b. Meaning of "Correct"

c. Meaning of "Taxable Event"

d. Meaning of "Correction Period"

(1) In General

(2) Extensions of Correction Period

(a) Extensions by Commissioner

(b) Extension for Payment of First-Tier Tax

(c) Extension for Filing Claim for Refund or Refund Suit

V. Accumulated Earnings Tax and Stock Redemptions

A. Introduction

B. Accumulated Earnings Tax

1. In General

2. Determination of Accumulated Earnings Credit

3. Reasonable Needs of the Business

a. Excess Business Holdings Redemption Needs

b. Regulations

(1) Regs. § 1.537-1(d)(1)

(2) Regs. § 1.537-1(d)(2)

(3) Regs. § 1.537-1(d)(3): Limitation upon Extent of Excess Business Holdings Redemption Need

(4) Regs. § 1.537-1(d)(4): Actual Acquisition of Stock by Private Foundation a Prerequisite

(5) Regs. § 1.537-1(d)(5)

(6) Regs. § 1.537-1(d)(6): Determination of Number of Shares

(7) Example

(8) Regs. § 1.537-1(e)(1)

(9) Regs. § 1.537-1(e)(3)

4. Rulings

C. Redemption Income Tax Aspects

1. From the Foundation's Standpoint

2. From the Corporation's Standpoint


Working Papers

Table of Worksheets

Worksheet 1 Outline of Regs. § 53.4943

Worksheet 2 Determining Whether a Supporting Organization Is Treated as a Private Foundation Subject to § 4943

Worksheet 3 Summary of Changes to Donor Advised Funds Under the Pension Protection Act of 2006

Worksheet 4 Model Option Agreement for Sale of Excess Business Holdings Received from an Estate or Revocable Trust