The IRS established rules against excess business holdings intended to keep private foundations from owning a significant stake in a family business. Breaking those rules can have serious consequences for the foundation.
Excess Business Holdings Defined:
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 percent 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 percent 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 two percent 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 percent (or 35 percent 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. (some exceptions apply, but are beyond the scope of this post).
Example: A foundation manager of X Foundation, owns 50 percent of the stock of Y Corporation. (Y Corporation is not actively engaged in a trade or business.) Z Corporation is an 80 percent-owned subsidiary of Y Corporation. Therefore, 40 percent of the Z Corporation stock is considered held by a disqualified person to X Foundation. Any holding of more than two percent of the voting stock or two percent of the value of the Z Corporation stock will result in all of the Z Corporation stock held by the foundation being treated as an excess business holding.
In making its computations, the foundation must determine its proportionate interest and that of all disqualified persons in each class of stock, in relation to the proportion that the voting interest of each class has to all votes in the corporation. For example, if the foundation owns 50 percent of the outstanding shares of a class of stock that has 60 percent of the voting rights in a corporation, the foundation's holdings in the voting stock would be 30 percent.
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.