3.7.0 IRC Section 4943—Excess Business Holdings

A private foundation may not own excess business holdings in any business enterprise.

3.7.1 Definition

1. The term excess business holdings is defined generally in IRC §4943(c). IRC §4943(d)(3) creates an exception from that definition for:

   1. A business functionally related to the charitable purposes of the private foundation [as defined in IRC §4942(j)(4)]; or

   2. A trade or business at least 95 percent of the gross income of which is derived from passive sources, such as passive rents, royalties, interest or dividends.

2. IRC §4943(c) sets up the definition in a backwards fashion. In general, it describes excess business holdings as the holdings in a business enterprise that the private foundation must distribute to a person other than a disqualified person in order for the remaining holdings of the private foundation to be permitted holdings.

3. Permitted Holdings

   1. Corporation

      1. In general, permitted holdings by a private foundation in a corporation are 20 percent of the voting stock, reduced by the percentage of the voting stock owned by all disqualified persons in the aggregate.

      2. In any case in which all of the disqualified persons in the aggregate do not own more than 20 percent of the voting stock of a corporation, nonvoting stock held by the private foundation is also treated as permitted holdings. [IRC §4943(c)(2)] It should be noted that a mere agreement by a private foundation not to vote its stock is not sufficient to insulate the foundation. The fundamental nature of the stock must be nonvoting.

      3. If it is established to the satisfaction of the Internal Revenue Service that effective control of the corporation is in one or more persons who are not disqualified persons with respect to the private foundation, then the private foundation and all disqualified persons together may own up to 35 percent of the voting stock of the corporation.

   2. Partnership

      For partnerships, the profits interest is treated as voting stock, so permitted holdings include 20 percent of the profits interest, and 35 percent of the profits interest if the partnership is effectively controlled by one or more persons who are not disqualified persons. The capital interest in the partnership is treated as nonvoting stock. [IRC §4943(c)(3)]

   3. In all other cases, a beneficial interest (such as in a trust) is treated as voting stock. [IRC §4943(c)(3)]

   4. Under the so-called de minimis rule of IRC §4943(c)(2)(C), a private foundation may hold up to two percent of the voting stock and two percent of the value of all outstanding classes of other stock.

   5. A private foundation may not hold an interest in a proprietorship. [IRC §4943(c)(3)(B)]

   6. There are special rules for business interests held on May 26, 1969, and business holdings acquired by trust or will dated before May 26, 1969. These special rules relate back to the year that private foundation regulation was enacted.

3.7.2 Disposition

1. A private foundation may not purchase excess business holdings. Where the excess business holdings are acquired other than by purchase, however, the private foundation has five years to dispose of the excess business holdings. [IRC §4943(c)(6)]

2. In the case of certain large gifts or bequests, the Internal Revenue Service may extend for an additional five-year period the period in which the private foundation has to dispose of the excess business holdings. [IRC §4943(c)(7)]

3.7.3 Excise Taxes

In the case of excess business holdings, a first tier excise tax is imposed equal to five percent of the value of the excess business holdings. If the excess business holdings are not distributed within the applicable correction period, a second tier tax is imposed equal to 200 percent of the total value of the excess business holdings. [IRC §§4943(a) and (b)]

3.7.4 Appropriate Disposition

It must be remembered that the private foundation may not dispose of the excess business holdings by sale to a disqualified person. This would constitute a prohibited act of self-dealing. The Treasury Regulations provide for an exemption with respect to estates during the period of the administration of the estate, but not thereafter even if the business holdings are acquired by bequest.