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By Deborah M. Beers, Esq. Buchanan Ingersoll & Rooney PC Washington, D.C.
Section 4941 imposes an escalating series of excise taxes on “disqualified persons” and foundation managers who engage in certain types of prohibited business transactions with a private foundation. “Disqualified persons” include substantial contributors to the private foundation, foundation managers (such as directors and trustees), and persons related to them, such as family members and related business entities. A corporation is a disqualified person with respect to a private foundation if disqualified persons own more than 35% of the total combined voting power of the corporation.
Under the self-dealing provisions, it is immaterial whether the transaction results in a benefit or detriment to the private foundation. Thus, the statute aims at prohibiting all almost all business transactions, including, but not limited to, sales and exchanges between a private foundation and related persons, regardless of the reasons for the transaction or its financial soundness.
However, there are certain expressed exceptions to this general prohibition. PLR 201624013 and PLR 201624001 illustrate one exception that applies to certain corporate redemptions.
Foundation was a private foundation and a shareholder of Company. Foundation was funded by certain family members who were current or former shareholders of Company, and it was managed by certain family members who were current shareholders of Company.
DISC was a domestic international sales corporation formed to export products. The shareholders of DISC are identical to the shareholders of Company, except Company was also a shareholder of DISC. The shareholders of DISC entered into a shareholder agreement that required any transfer of Company stock to be accompanied by a transfer of an equal amount of DISC stock. Company and DISC were both disqualified persons with respect to Foundation.
Foundation owned nonvoting common stock in Company (which also had voting common stock) and voting common stock in DISC.
Company and DISC, through their respective boards of directors, authorized a redemption of Company's nonvoting common stock and DISC's voting common stock from any shareholder regarding certain stock from any shareholder. The proposed redemptions involved Company's nonvoting common stock and DISC's voting common stock. Any shareholder that chose to participate in the redemption with Company was also required to participate in the redemption with DISC, in accordance with the DISC shareholder agreement. Foundation intended to participate in the proposed redemptions for various reasons, “including liquidity to facilitate its charitable endeavors.”
The redemption price would be payable in cash in an amount equal to the fair market value of the stock as determined by an independent appraisal. It would be limited to a fixed dollar amount, and, if that amount was exceeded, reductions would be made on a pro rata basis. Under the terms of the proposed redemptions, no shareholder would receive any preferential treatment regarding any aspect of either redemption.
On the foregoing facts, the IRS ruled that the proposed redemption of nonvoting common stock by Company and voting common stock by DISC would not constitute acts of self-dealing under §4941.
Although §4941(d)(1) defines an act of self-dealing as including a sale or exchange of property between a private foundation and a disqualified person, §4941(d)(2)(F) and Reg. §53.4941(d)-3(d)(1) provide that a transaction between a private foundation and a corporation which is a disqualified person pursuant to a redemption shall not be an act of self-dealing if all of the securities of the same class as that held by the foundation were subject to the same terms “and such terms provide for receipt by the foundation of no less than fair market value.”
Reg. §53.4941(d)-3(d)(1) further provides that the securities will not be subject to the “same terms” unless the corporation makes a bona fide offer on a uniform basis to the foundation and every other person who holds such securities. Moreover, Reg. §53.4941(d)-3(d)(1) also explains that it will be evidence that the redemption offer was not made on a uniform basis if the foundation receives property, such as a promissory note, while other persons holding securities of the same class receive cash. In these PLRs, the redemption offer was made on a uniform basis and all parties would receive cash, and thus the IRS concluded that the regulation conditions were satisfied. The IRS also noted that the fact that the redemption of Company stock and DISC stock were required to be done together did not detract from the uniform nature of the offer by Company and DISC.
Although not discussed in these PLRs, as mentioned in Berry, 470 T.M., Private Foundations — Self-Dealing (Section 4941), “[t]he IRS has applied §4941(d)(2)(F) even where it is clearly anticipated that only the foundation will accept a corporation's redemption offer made to all shareholders on a uniform basis and also where it is anticipated that only disqualified persons (and not the foundation) will accept such offer.” This ability to participate unilaterally makes the redemption exception to self-dealing particularly valuable when seeking to monetize a private foundation's interest in a family enterprise.
The IRS, in private rulings, has extended the corporate redemption exception to the dissolution or liquidation of a private foundation's interest in a partnership that is a disqualified person, reasoning that the same rationale should apply.
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