Excess Business Holdings (IRC Section 4943)
As a general rule, private foundations are prohibited from controlling any business. They are also prohibited from owning more than 20% ownership in any business. When determining the amount of ownership in a business, the foundation must add to its own ownership shares the ownership shares of all disqualified persons. This ownership limitation applies to ownership in corporations (where voting stock is used to measure ownership), partnerships and joint ventures (where profits interest is used to measure ownership), and unincorporated enterprises (where beneficial interest is used to measure ownership).
Important exceptions to this restriction on excess business holdings exist including:
- Private foundations may own as much as 35% of a business provided that the "effective control" of that business is not held by disqualified persons. Effective control is defined as direct or indirect power over the direction of the management and policies of a business.
- If a private foundation holds 2% or less ownership in a business then those holdings are exempt from the restriction on excess business holdings regardless of how much ownership is held by disqualified persons.
Ownership or interests in certain types of businesses are exempt from the excise tax on excess business holdings. These exemptions include:
- Functionally related businesses - These are businesses whose conduct is substantially related to the exempt purposes of the private foundation
- A business which derives 95% or more of its gross income from passive sources such as rents, dividends or royalties
- Program-related investments - Program-related investments, or "PRI"s, are investments that do not attempt to influence legislation nor participate in a political campaign, do not have the production of income nor the appreciation of property as a significant purpose, and that are made primarily to further some aspect of the foundation's exempt purposes
- If a private foundation acquires additional ownership or interest in a business other than through purchase (such as through a bequest or gift) that causes it to have excess business holdings, these amounts are not subject to the excise tax on excess business holdings provided that the foundation disposes of the excess holdings within a 5-year period. In some special cases where the gift or bequest is particularly large, this initial 5-year period may be extended for an additional 5 years.
- Certain excess holdings that a foundation acquires by means other than by purchase are not subject to the excise tax on excess business holdings provided that the foundation disposes of those excess holdings within 90 days of knowing or has reason to know that it has excess business holdings.
Amount of the tax:
- 10% of the value of the excess business holdings. If the amount of the excess business holdings varies within a tax year, then the tax is imposed on the day when the excess holdings were greatest
- Additional excise tax of 200% of the excess business holdings is imposed if the foundation has not disposed of the excess business holdings by the end of the taxable period