Wednesday, August 15, 2012

IRS Extends Private Foundation’s Window for Disposing of Excess Business Holdings

The IRS recently released a private letter ruling granting the request of a private foundation to extend the period for disposing of its excess business holdings by an additional five years. The foundation received a gift of units of a limited liability company (“LLC”) that caused it to have excess business holdings, which normally must be disposed of within five years under section 4943(c)(6)(A) of the Internal Revenue Code (the “Code”). However, Code section 4943(c)(7) authorizes the IRS to extend for an additional five years the initial five-year period “in the case of an unusually large gift or bequest of diverse business holdings or holdings with complex corporate structures” if certain conditions are satisfied. Among them, the foundation must show the following:

[I]t made diligent efforts to dispose of such holdings during the initial five-year period, and … disposition within the initial five-year period has not been possible (except at a price substantially below fair market value) by reason of such size and complexity or diversity of holdings….

In granting the private foundation’s request, the IRS was persuaded that certain terms of the LLC operating agreement adversely affected the value of the LLC interests so as to trigger the statutory grounds for relief. In relevant part, the ruling reasons as follows:

Based on a strategic buyer valuation analysis … you concluded that LLC's value in 2013 may be almost double its value in 2010. Thus, you would have incurred a substantial loss if LLC had been sold in 2010 (compared to a sale in 2013), which would have diminished your capability to continue to accomplish your tax-exempt purpose, since your interest in LLC comprised e% of your total assets.

You also state that you could have sold at least a portion of your interest in LLC in a 2011 tender offer, but such a sale would have been at a price that you believe was substantially below fair market value. In addition, you believe that accepting the tender offer at the price it was offered would have diminished your capability to continue to accomplish your tax-exempt purpose.

Further, restrictions placed on interests in the LLC pursuant to LLC's Operating Agreement have made it difficult for you to dispose/sell your LLC interest. First, the LLC has a right of first refusal over any proposed sale to a third person. Second, d% of the members have tag-along rights; this means "that any prospective buyer of the Foundation's interest would also have to purchase the interests of those other [d%] owners."

Thus, as required under section 4943(c)(7), you have shown that you have made diligent efforts to dispose of your holdings during the initial five-year period, and that disposition within the initial five-year period has not been possible (except at a price substantially below fair market value) by reason of such size and complexity or diversity of holdings.

The ruling is noteworthy in its liberal interpretation of the statutory grounds for extending the period for disposing of excess business holdings. It treats an LLC’s right of first refusal over sales of LLC interests and members’ “tag-along rights” as creating a “complex corporate structure” within the meaning of section 4943(c)(7). Counsel drafting operating agreements, partnership agreements, and other documents governing closely held business should keep this ruling in mind during the drafting stage if future gifts of business interests to a private foundation are contemplated.

The ruling is Priv. Ltr. Rul. 2012-32-038 (May 24, 2012) and is reported in Tax Notes Today (electronic citation: 2012 TNT 156-30).

JRB

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