Co-authored by Anthony Perillo, CFP®, Financial Advisor at Wipfli Financial Advisors
The following article was prepared in collaboration with our affiliate, Wipfli LLP. With more than 2,000 associates across the United States and in India, Wipfli ranks among the top accounting and business consulting firms in the nation.
When actor and philanthropist Paul Newman died in 2008, he left Newman’s Own, Inc., his popular food and beverage company, to the Newman’s Own Foundation. If you have seen Newman’s Own products in a grocery store (and chances are, you have), you’re familiar with the “100% Profits to Charity” slogan displayed prominently on their salad dressing bottles, lemonade cartons and pasta sauce jars. It only makes sense that this philanthropic business should be owned by a charitable foundation, right?
Unfortunately for the Newman’s Own Foundation, this wasn’t quite so simple. Under Section 4943 of the Internal Revenue Code, the foundation was required to divest at least 80% of its business ownership or it would face steep tax penalties. After years of advocating for an exception,1 and with a late 2018 deadline for divestiture looming, the Newman’s Own Foundation finally was granted relief when the Bipartisan Budget Act of 2018 was signed into law earlier this year. That act included the Philanthropic Enterprise Act of 2017,2 which created an exception to Section 4943 for certain philanthropic business holdings and effectively allowed the Newman’s Own Foundation to continue to own 100% of its business without any negative tax consequences.
While this exception is not available for donor-advised funds, Type III supporting organizations and charitable trusts, it opens the door to new planning opportunities for private foundations and businesses owners and allows them to join forces for a purpose that may create something greater than the sum of its parts.
Effective beginning January 1, 2018, the bill states that private foundations must meet the following criteria in order to take advantage of this niche planning opportunity:
Exclusive ownership. The foundation must own 100% of the voting stock in the business at all times during the taxable year.
Not a purchase. The foundation’s interest in the business must be acquired by some other means than a purchase, such as a bequest under will or trust or through a gift.
All profits to charity. One-hundred percent of the business’s net operating income must be distributed to the foundation. There is a 120-day window to meet this requirement upon the close of the tax year.
Independence. No “substantial contributor” to the foundation can serve as director, officer, trustee, manager, employee, contractor or in any similar position to the business. The ruling applies this limitation further by including the contributor’s family members as well.
Board majority. The foundation’s board must be majority comprised of individuals who are not directors or officers of the business or family members of a substantial contributor.
No loans. There can be no outstanding loans from the business to a substantial contributor, which is expanded again to include the contributor’s family members.
Although this exception is relatively narrow and tailored to the Newman’s Own situation, the new law does allow other private foundations the same ability to avoid the excise tax imposed on excess business holdings previously applied under Section 4943, provided they meet the conditions outlined above.
The following are some examples of cases where this exception may provide a planning opportunity:
— Charitably-inclined business owners without children or clear successors for the business
— Owners of a wholly-owned or closely-held business who want to use their business to leave a charitable legacy (note that if there is more than one owner of voting stock, all owners must agree to transfer their stock to the foundation together in order to comply with the exclusive ownership requirement)
— Business owners who have built substantial family wealth outside of their business and don’t feel the need to transfer the business to heirs
— Business owners with taxable estates who are concerned that estate tax issues may force a sale of the business to an undesirable third party
— Owners of a philanthropic business who want to ensure that the business continues to carry on their mission after they are gone
All too often in tax planning, a person’s true intentions may need to take a side seat when tax rules and regulations limit or restrain the most preferred path. This law serves as a rare example of the government making an exception to help ensure a business’s vision for a philanthropic legacy is realized without compromise.
There are many caveats to this complex ruling, and your specific situation may contain circumstances that require additional and careful planning in order to navigate it effectively. Partnering with a dedicated team of planning professionals can help you make the most of this new exception — for example, they can help preserve some control of your private foundation for you and your family through properly planned appointment and designation rights.
If you think this ruling may present a planning opportunity for your specific situation, speak with a Wipfli advisor today.