Friday, February 16, 2018
So I teased yesterday that I was looking at the statutory language of new Code Section 4943 with my estate planning hat on. I fully admit I'm spitballing here and haven't taken this all the way through, so work with me. Recall from yesterday that there is a three-part test for new Section 4943(g): Ownership of voting control, receipt of net operating income, and an independent board. Here is the statutory language for the first requirement, ownership of voting control:
(2) OWNERSHIP. —The requirements of this paragraph are met if—
(A) 100 percent of the voting stock in the business enterprise is held by the private foundation at all times during the taxable year, and
(B) all the private foundation’s ownership interests in the business enterprise were acquired by means other than by purchase.
So note that the foundation must receive 100% of the "voting stock." This leads me to two questions. First, does that necessarily imply that one could have non-voting stock? After all, Section 4943(c)(2) specifically talks about voting stock and, thereafter, what happens with the non-voting stock as permitted holdings by the foundation. (By the way, the Regulations specifically state, for purposes of determining permitted holdings, voting means voting for the election of directors. Reg. 53.4943-3(b)(1)(ii)). Could, for example, the donor’s children own non-voting stock?
Question number 2, of course, is whether voting stock really means "stock" - as in corporate stock. Which means an actual state law corporation, or would an LLC that checks the corporate box count? Could you do this with a LLC taxed as a partnership? There's a whole layer of UBIT planning there as well, I know... so that would inform that choice. That being said, Section 4943(c)(3) specifically gives guidance on the permitted holdings issue for non-corporate entities and directs Treasury to promulgate regs on that, although that doesn't apply by its terms to new Section 4943(g). The new Section is just silent, so it’s not clear whether this is bad drafting or intentionally limited to corporations (compare, for example, Section 4941(d)(2)(F) regarding corporate reorganizations).
Now one might say that the second requirement of Section 4943(g), the net income distribution requirement, would limit any gamesmanship. Here’s the language:
(3) ALL PROFITS TO CHARITY. —
(A) IN GENERAL. —The requirements of this paragraph are met if the business enterprise, not later than 120 days after the close of the taxable year, distributes an amount equal to its net operating income for such taxable year to the private foundation.
(B) NET OPERATING INCOME. —For purposes of this paragraph, the net operating income of any business enterprise for any taxable year is an amount equal to the gross income of the business enterprise for the taxable year, reduced by the sum of—
(i) the deductions allowed by chapter 14 for the taxable year which are directly connected with the production of such income,
(ii) the tax imposed by chapter 1 on the business enterprise for the taxable year, and
(iii) an amount for a reasonable reserve for working capital and other business needs of the business enterprise.
Note that the net operating income provision is keyed off gross income (statutory construct) minus deductions (more statutory constructs) and a working capital reserve (fiduciary duty to non-voting shareholders? Hmmm..) This isn’t off something like E&P in the C Corporation context or partner capital in the Sub K context, which takes into account economic inflows and outflows that don’t hit gross income or deductions (because they are statutory constructs people!) Say, for example, the business has real estate throwing out losses? Or holds a life insurance policy of $2.0 million on the donor. In the first instance, all the deductions; in the second, there’s no gross income to begin with. Could some of the value of the company that isn’t technically included in operating income get allocate to share value (or specifically, non-voting share value?)
Could you draft a class of voting stock with only economic rights to net operating income so defined, leaving everything else to the non-voting shares? Could you do it in a member-managed LLC that checks the box as a corporation, but structures the governance so as to avoid the tests in the third requirement of independent management?
So many question… no answers at all. I’m sort of glad I’m not doing this planning any more….