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Background, definitions and rules for excess business holdings

To prevent a private foundation and its insiders from being able to control a business enterprise, the IRS limits the amount of stock the foundation and its disqualified persons can hold, to prevent what is known as excess business holdings.

Foundation Source works with its clients to help them understand the many nuances and exceptions to the excess business holdings rules, so they don’t run afoul of IRS regulations.

What is the Definition of Excess Business Holdings

The excess business holdings of a foundation are the amount of stock or other interest in a business enterprise that exceeds the permitted holdings. A private foundation is generally permitted to hold up to 20% of the voting stock of a corporation, reduced by the percentage of voting stock actually or constructively owned by disqualified persons. There are two exceptions to this rule.

  1. If one or more third persons, who are not disqualified persons, have effective control of a corporation, the private foundation and all disqualified persons together may own up to 35% of the corporation’s voting stock. Effective control means the power, whether direct or indirect, and whether or not actually exercised, to direct or cause the direction of the management and policies of a business enterprise. It is the actual control which is decisive, and not its form or the means by which it is exercisable.
  2. A private foundation is not treated as having excess business holdings in any corporation in which it (together with certain other related private foundations) owns not more than 2% of the voting stock and not more than two percent of the value of all outstanding shares of all classes of stock.

Nonvoting stock (or capital interest for holdings in a partnership or joint venture) is a permitted holding of a foundation if all disqualified persons together hold no more than 20% (or 35% as described earlier) of the voting stock of the corporation. All equity interests which are not voting stock shall be classified as nonvoting stock.

Interest in Sole Proprietorships

A private foundation is not permitted any holdings in sole proprietorships that are business enterprises unless they were held before May 26, 1969 or acquired by gift or bequest thereafter.

Attribution of Business Holdings

For determining the holdings in a business enterprise of either a private foundation or a disqualified person, any stock or other interest owned directly or indirectly by or for a corporation, partnership, estate, or trust is considered owned proportionately by or for its shareholders, partners, or beneficiaries. (This rule does not apply to certain income interests or remainder interests of a private foundation in a split-interest trust.)

Dispositions of Certain Excess Holdings within 90 Days

A private foundation that acquires excess business holdings, other than as a result of a purchase by the foundation, will not be subject to the taxes on excess business holdings if it disposes of the excess business holdings within 90 days from the date on which it knows, or has reason to know, of the event that caused it to have the excess holdings. This 90–day period will be extended to include the period during which a foundation is prevented by federal or state securities laws from disposing of the excess business holdings. The 90–day disposition period applies, for example, when a disqualified person acquires additional holdings. The amount of holdings the foundation must dispose of is not affected by disposals by disqualified persons during the 90–day period.

Taxes on Excess Business Holdings

Generally, under section 4943 of the Internal Revenue Code, the combined holdings of a private foundation and all of its disqualified persons are limited to 20% of the voting stock in a business enterprise that is a corporation. The 20% limitation also applies to holdings in business enterprises that are partnerships, joint ventures, or other unincorporated enterprises. For a partnership or joint venture, profits interest is substituted for voting stock, and for any other unincorporated enterprise, beneficial interest is substituted for voting stock. A private foundation that has excess business holdings in a business enterprise may become liable for an excise tax based on the amount of the excess holdings.

Initial Tax

An excise tax of 10% of the value of the excess holdings is imposed on the foundation.  The tax is imposed on the last day of each tax year that ends during the taxable period.

The amount of the excess holdings is determined as of the day during the tax year when the foundation’s excess holdings in the business were the greatest.

The initial tax may be abated if the foundation can show that the excess holdings were due to reasonable cause and not to willful neglect, and thatConta  the excess holdings were disposed of within the correction period.

For purposes of the taxes under section 4943, certain donor-advised funds and supporting organizations are treated as private foundations.

Additional Tax

After the initial tax has been imposed, an excise tax of 200% of the excess holdings is imposed on the foundation if it has not disposed of the remaining excess business holdings by the end of the taxable period. The additional tax will not be assessed, or if assessed will be abated, if the excess business holdings are reduced to zero during the correction period.

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