Thursday, February 15, 2018
It's In There! The Newman's Own fix in the Bipartisan Budget Act of 2018
Section 41110 of the Bipartisan Budget Act of 2018 includes the so-called Newman’s Own provision – an amendment to Code Section 4943 (the private foundation excise tax on excess business holdings) that would allow a private foundation to own a significant stake in an operating business under certain circumstances. By all reports, the foundation that owns Newman’s Own is subject to Code Section 4943, and would need to liquidate its holdings in the company in short order without legislative changes to Code Section 4943.
As you may know, Code Section 4943 provides that a private foundation may not own an “excess” holding in a operating business. Very generally, the excess holding for an operating business in corporate form is equity having 20% of the corporation's voting power reduced by the voting power held by “disqualified persons” – typically, substantial contributors, foundation managers, and their family and related entities under Code Section 4946. If a foundation holds an excess business holding by gift or inheritance (e.g., Paul Newman dies and leaves all his stock to his foundation), the foundation has five years to dispose of the excess holding. If the foundation could demonstrate that it could not dispose of the holding despite its efforts during that five year period, the Service could grant a discretionary additional five years.
New Code Section 4943(g) would allow a private foundation to hold 100% of the voting stock of an operating business if it acquires those interests by gift, it receives the net operating income of from the business annually, and the business and the foundation are operated independently, as determined by certain board composition rules. Presumably, this would allow Paul Newman's foundation to continue to own Newman's Own and receive the proceeds from operation.
I am not going in to the details of the actual language of the statute (yet…) – there are some questionably drafted provisions (shocking…) that raise some issue I’m still thinking about. No worries, I’m here all week.
That being said, I am troubled by this provision as a general matter. First, the idea of changing statutes for specific taxpayers, no matter how well-intentioned and deserving (I love the salsa….), is always distasteful to me. Now, I’m not so naïve that I don't know that it happens all the time (I’m looking at you, motorsports facilities and the Orange Bowl and race horses…) but it doesn’t mean it’s good practice and one that should be lauded.
More to the substance, however, this new provision really flies in the face of the whole purpose of Code Section 4943. If you read the legislative history (which I have and have helpfully summarized for you here: (shameless plug): Better Late Than Never: Incorporating LLCs Into Section 4943)), you find that the original intent behind Code Section 4943 was not really about prohibiting self-dealing. After all, Code Section 4941 (the self-dealing prohibition) was passed at the same time. Code Section 4943 is about focus: is the foundation focusing on its charitable endeavors, or it is spending a more than insubstantial amount of its time running a business? It is, to some degree, understandable that the foundation would pay close attention to the primary source of its income. That being said, the source of the private foundation’s exemption is its charitable program, and if that program suffers in the shadows of operation of a substantial business subsidiary, what is the point of exemption? Do we still believe that the destination of income test is not a thing? In my mind, none of the requirements of new Code Section 4943(g) address this concern directly.
I suspect my discomfort will grow as my estate planner hat takes over, but in the meanwhile, pass the tortilla chips.
P.S. I know “It’s In There” was Prego – you try making a pithy headline involving tax and pasta sauce.
With respect to your comment about the purpose of Section 4943, I feel compelled to point out that, as you correctly note, the new law specifies that the foundation is only protected if the operation and management of the business are kept separate from the operation and management of the foundation. This goes further than just board composition, and we can expect future regulations to make that clear. And while It is of course true that foundation boards are supposed to focus on mission, they do not (and should not) do so to the exclusion of other factors, such as the foundation's sources of revenue and/or its investment performance. Personally, I am not at all disturbed by the fact that the board of Newman's Own Foundation will spend time making sure the food company is well-run and that it continues to provide profits that can be used for charitable purposes for a long time to come. And if (for reputational reasons) they use their influence to make sure that the company is well-regarded and operates responsibly, to my mind that's all to the good. After all, it is a foundation asset.
IMHO, the excess business holdings rule, like the commerciality doctrine, is woefully out of date and has probably outlived its usefulness in terms of legitimate tax policy.
Posted by: Allen Bromberger | Feb 16, 2018 12:03:04 PM