From David T. Leibell and Daniel L. Daniels of Cummings & Lockwood LLC, in Stamford, Conn., we have this update:

  • IRS denies private foundation's request for five-year extension to dispose of excess business holdings. In Private Letter Ruling 200552018 (released Dec. 30, 2005), the Internal Revenue Service rejected the request of a private foundation seeking an additional five years to dispose of excess business holdings as defined in Internal Revenue Code Section 4943. The reason: the foundation had failed to provide a plan of disposition that could reasonably be expected to succeed by the end of any five-year extension period, as required by IRC Section 4943(c)(7).

Section 4943 imposes an excise tax on a private foundation's excess business holdings. A foundation has excess business holdings when its holdings, together with those of “disqualified persons” (for example, substantial contributors, certain family members and entities controlled by these categories of people), exceed 20 percent of the voting control of a business. Business holdings do not include interests in a business that is substantially related to the foundation's exempt purposes, or interests in a business in which at least 95 percent of the gross income is derived from passive sources. Permitted aggregate holdings are increased from 20 percent to 35 percent if it can be shown that effective control of the business is in one or more individuals who are not “disqualified persons” with respect to the foundation. Effective control means the possession, directly or indirectly, of the power to direct or cause the direction of the business's management and policies. Under a de minimis rule, a foundation will not be treated as having excess business holdings in any business in which it owns 2 percent or less of the voting control of the business, regardless of the ownership percentages of disqualified persons.

If a foundation has excess business holdings, it must dispose of them within five years of receipt. During the five-year period, the foundation will not be subject to tax on the excess business holdings. If after this grace period the foundation has not disposed of the excess business holdings, it is subject to an initial excise tax equal to 5 percent of the excess business holdings. If these holdings are not disposed of in a timely manner after the initial tax is imposed, an additional excise tax equal to 200 percent of the excess business holdings is imposed. A foundation that cannot dispose of the excess business holdings within the five-year grace period can request an extension of up to an additional five years to dispose of the holdings before any initial excise tax is imposed. But the Service is not required to grant the extension.

IRC Section 4943(c)(7) allows the Service to extend the period for disposing of an unusually large gift or bequest of diverse business holdings or holdings with complex business structures if the foundation establishes that (1) diligent efforts to dispose of such holdings have been made within the initial five years, and (2) disposition within the initial five years was not possible (except at a price substantially below fair market value) by reason of the size and complexity or diversity of the holdings. In addition, before the end of the initial five years, the foundation must submit to the Service and the applicable state attorney general, a plan for disposing of all the excess business holdings involved in the extension request. Finally, the IRS must determine that the plan can reasonably be expected to be carried out before the close of the extension period.

In PLR 200552018, a foundation and its disqualified persons owned the majority of shares of the common stock of J, a publicly traded company, resulting in a problem of excess business holdings. Shortly before the end of the five-year grace period (Dec. 16, 2004), the foundation requested from the IRS an extension of time to dispose of the excess business holdings. The foundation claimed that during the grace period, it had been attempting to sell all of its J stock in a single transaction, and during that process the foundation was prohibited from selling stock on the open market by the Securities and Exchange Commission. The foundation indicated that if the sale in a single transaction was not possible, it could take up to four additional years to sell the J stock on the open market. On Jan. 26, 2005, the foundation informed the Service that it had conducted an auction for the sale of all of its J stock and had received a bid of $3.05 per share. Shortly after the auction, J released a very positive earnings report and in the succeeding days its stock price rose dramatically from where it had traded at the time of the auction. As a result, the foundation decided not to sell to the winning bidder at the auction. The foundation decided instead to sell shares piecemeal on the open market and stated to the Service that it would “continue to sell as many shares on a daily or weekly basis as will not violate the Company's insider trading policies or unduly undercut the trading value of the shares.” Other than that, no real plan of disposition of the excess business holdings was provided to the Service. In March, 2005, J released lower earnings and the stock price dropped dramatically.

In denying the five-year extension to dispose of the J stock, the Service found that the foundation had failed to provide a plan of disposition that could reasonably be expected to be successfully carried out by the end of any five-year extension period. The reduction in the price of the stock, without a specific plan of disposition, did not constitute a basis for granting the extension. The Service did grant a much shorter extension (until March 31, 2006) to the foundation to dispose of the excess business holdings.

What could this foundation have done differently in order to have increased its chances of obtaining the additional five-year extension? Essentially telling the IRS, “we'll sell the stock whenever the price is right,” is not exactly a plan with a deadline. In contrast, the foundation in PLR 9115061 did it right: The foundation exercised a significant degree of care in dealing with its excess business holdings problem before its initial five-year period expired, including hiring an independent financial consultant to prepare a detailed plan of disposition for the excess holdings and obtaining approval of that plan from the state attorney general. IRC Section 4943(c)(7) lays out a clear and concise roadmap for obtaining an extension. It pays to adhere to this roadmap.