Private foundations may now own philanthropic businesses whose profits are dedicated to charity without the prohibitive excess business holdings tax. Newman’s Own Foundation was the proponent of recent legislation that allows it to continue to own 100% of Newman’s Own, the food company founded by Paul Newman and bequeathed to the foundation upon his death. Newman’s Own has contributed all of its profits to charity since its founding in 1982.
Private foundations and their disqualified persons are generally permitted to hold up to 20% (or in certain cases up to 35%) of the voting stock of a corporation under the excess business holding rules. These rules have previously prevented a private foundation from owning a business even if all of its profits are dedicated to charity.
The Bipartisan Budget Act of 2018 contained the Philanthropic Enterprise Act, which amended the excess business holdings rules to allow Newman’s Own and similar private foundations to own businesses that meet certain conditions. The excess business holdings rules now have an exception for philanthropic businesses that satisfy the following conditions:
- Hold 100% of voting stock. The private foundation holds 100% of the voting stock of the philanthropic business
- Receive business by gift or bequest. The private foundation received its ownership interests in the business by means other than purchase
- Independent foundation board. The private foundation board has a majority of directors who are not directors or officers of the business enterprise, or family members of a substantial contributor
- Business independent of donor family. The business cannot have substantial contributors or their family members as directors, officers, employees, or contractors, and cannot make any loans to substantial contributors or their family members
- All profits to charity. The business must distribute its post-tax net operating income to the private foundation each year (with a reasonable reserve for business needs)
The exception does not apply to businesses that are owned by other types of entities also treated as private foundations for purposes of the excess business holdings rules, including donor advised funds, supporting organizations, nonexempt charitable trusts, and split-interest trusts.
New Law Addresses Historical Concerns of Private Foundations Owning Businesses
The excess business holdings rules were originally designed almost 50 years ago to address a range of concerns about foundations controlling active businesses. These included concerns that foundation-owned businesses would be operated to benefit family members rather than the charity and that foundation managers would devote their attention to the operation of the business rather than attend to their charitable duties. Another concern was that “[a] remarkable number of foundation-owned enterprises proceed from year to year realizing substantial profits, but making negligible or no distributions to their parent organizations.”
The excess business holding rules were enacted in 1969 to address these concerns but did so with a broad brush that effectively prohibited private foundations from long-term ownership of substantial interests in most business enterprises. The amendment allows foundations to hold businesses in a structure that addresses each of these areas of concern, while allowing donors to commit the profits of their business to charity in perpetuity.
Planning Points When Considering a Philanthropic Business Enterprise
Socially-minded business owners who wish to devote the profits of their business to charity while making a charitable contribution of their business to a private foundation should consider the following planning points:
- Identify appropriate directors of the foundation and the business who will meet the independence requirements
- Review arrangements between the business and the donor, family members, or other disqualified persons that may conflict with the independent operation requirement and the private foundation self-dealing rules
- Determine if any changes in the tax status or structure of the business would be necessary. For instance, many businesses are S-corporations and if the donor contributed the stock of an S-corporation to the private foundation, all income of the S-corporation would be included in the foundation’s unrelated business taxable income—even from sources that would be otherwise exempt from tax. Revocation of an S-corporation election should be planned for carefully and in conjunction with a contemplated charitable contribution deduction
- Review the nature of the underlying business to see whether certain passive income-producing activities might be carried on more efficiently by the tax-exempt parent, and if so, whether the tax cost of transferring those assets to the parent might be offset by the tax benefits
- Consider alternatives. The new rules make ownership by a private foundation possible but there are other options as well. For example, in the case of a donor making a lifetime gift, a contribution to a public charity will likely generate a higher charitable contribution deduction. In addition, prior to the new tax act, some private foundations used ESOPs as a vehicle for addressing excess business holding issues. Read our prior LawFlash to learn about other methods for socially-minded taxable businesses to support charitable causes.