Every so often, business owners bequeath their businesses to their private foundations (PFs). Perhaps they have no obvious heirs, perhaps they feel they’ve sufficiently provided for their family or perhaps they’re driven by significant philanthropic desires. Some owners even leave their business to a PF in the hope that it can continue the business indefinitely. Whatever the motive, such a disposition will be a significant challenge for the executor.
Unfortunately, since 1969, PFs have been precluded from owning a significant interest in an operating business for more than five years after the closing of an estate.1 This situation leaves the executor with a problem because a PF can’t own more than 20 percent of the voting stock of an operating business, and that 20 percent is reduced by any stock owned by a surviving spouse, ancestors and descendants of the decedent, substantial contributors to the PF or PF board members.2 Notice that siblings and more remote relatives, such as aunts and cousins, aren’t counted, unless they’re board members of the PF or have donated to the PF. So, if a decedent bequeaths his 20 percent of the family business to his PF, with the remaining 80 percent owned by his siblings, the business could be held in the PF. If his children owned the 80 percent, the PF would need to dispose of its shares. If a third party has control of the business, the threshold is 35 percent, rather than 20, but this exception is rarely met.
Occasionally, the owner has planned ahead for the need to sell the business to fund the PF: There’s a clearly laid-out plan in his estate-planning documents for a sale to an unrelated purchaser, the purchaser has sufficient funds to purchase the business outright for cash and there are no objections to the sale from other heirs or potential heirs. Less lucky executors may have no plan stated in the estate-planning documents, the only logical purchasers are related parties or the logical purchasers may not have the funds to purchase the business outright. Why would it matter if the expected purchasers are related to the decedent or the PF? PFs are subject to the self-dealing rules.3 Among the restrictions imposed on PFs is a prohibition on sales or loans between the PF and the related parties mentioned above.4 This restriction would seem to leave many executors between the proverbial rock and a hard place: They have to sell the estate’s interest in a family business, but many members of the family and their related entities are ineligible purchasers.
Luckily, the Treasury regulations carve out a very useful exception for this exact situation: call it “the estate period of administration” exception.5 This regulation allows the executor to sell to otherwise prohibited parties during the estate (or trust) period of administration, as long as certain conditions are met. The estate can even finance the sale, and the resulting note can be held by the PF.6 As you would expect, the sale must be for fair market value and on reasonable terms. What often surprises the family is that the local probate court must approve the terms of the sale. For someone who’s planned his estate through trusts for privacy reasons, this particular requirement may be a roadblock. If that’s a serious impediment to using this exception, there’s another one available that doesn’t require court approval. This second exception is available any time, not just during an estate administration: A corporation can redeem stock held by a shareholder, for cash, even if that sale would otherwise be prohibited because the corporation is owned by the related parties.7 The corporation must offer the same redemption to all the shareholders, even if everyone knows that only the estate or PF will accept the offer.
For professionals working with testators who are considering such a bequest, planning begins with breaking the news that the PF will have to sell, so that appropriate alternatives are included in the estate documents. Clients should consider including an option provision in their will or revocable trust.8 In the alternative, advisors should be prepared for a sale of the business after death, while working within the parameters of the Internal Revenue Code.
—This publication contains general information only and Deloitte is not, by means of this publication, rendering accounting, business, financial, investment, legal, tax, or other professional advice or services. This publication is not a substitute for such professional advice or services, nor should it be used as a basis for any decision or action that may affect your business. Before making any decision or taking any action that may affect your business, you should consult a qualified professional advisor. Deloitte, its affiliates and related entities, shall not be responsible for any loss sustained by any person who relies on this publication.
1. Internal Revenue Code Section 4943 and Treasury Regulations Section 53.4943-6(b)(1).
2. IRC Sections 4943(c) and 4946.
3. IRC Section 4941.
4. IRC Section 4941(d).
5. Treas. Regs. Section 53.4941(d)-1(b)(3).
6. Treas. Regs. Section 53.4941(d)-2(c)(1).
7. IRC Section 4941(d)(2)(F) and Treas. Regs. Section 53.4941(d)-3(d).
8. Treas. Regs. Section 53.4941(d)-1(b)(3)(i)(c).