Article
Excess business holdings: What they are and what they mean for your private foundation
April 22, 2015 · Authored by Patty Mayer
Putting too many eggs in one basket — or overinvesting one company — isn’t only risky; for private foundations, it’s also punishable.
Under the excess business holdings rules, percentage thresholds determine how much ownership a foundation and certain associated persons may hold in a business enterprise and for how long. Exceed those thresholds and your foundation may find itself paying a hefty excise tax. Thoughtful procedures for monitoring enterprise investments will help your foundation stay out of hot water — but to do that, you’ll need some background: why the rules exist, which holdings qualify, who can hold them, and how long you have to correct any excess business holdings situation. We’ll cover each of these in turn.
The excess business holdings rules were enacted by Congress more than 40 years ago to limit individuals’ ability to retain control of a business enterprise by setting up a private foundation and transferring substantial ownership to the private foundation. The result of those rules is that private foundations are limited in the percentage of ownership they may have in a business enterprise. The rules lay out a fixed period of time for disposing of excess business holdings and control who may receive them. (In short, they cannot be sold to a disqualified person, which we’ll cover in greater detail later.) Certain support organizations and donor-advised funds are now also required to comply with the same rules.
What are excess business holdings?
An excess business holding exists when a foundation and its disqualified persons’ combined holdings in a business enterprise exceed set percentage thresholds. For these purposes, business enterprises include corporations, partnerships, trusts, and their holdings. Limitations on excess business holdings are calculated using the following ownership definitions:
- For incorporated businesses, both voting and nonvoting ownership stock are included.
- For partnerships “voting stock and nonvoting stock” is substituted with “profits and capital interests.”
- For trusts, the rules are applied by substituting beneficial interest for voting stock.
It’s important that private foundations set up procedures to monitor business enterprise investment ownership, especially when these investments also are held by disqualified persons.
What business enterprises are excluded?
An investment in a trade or business that derives at least 95% of its gross income from passive sources isn’t considered a business enterprise for purposes of the excess business holdings rules. For example, a private foundation could invest in various partnerships that generate passive income — interest, dividends, royalties, capital gains, or rents from real property. Second, an enterprise that performs an activity related to the exempt purpose of the organization — that is, a functionally related business — wouldn’t be considered a business enterprise for purposes of these rules.
The information provided here is of a general nature and is not intended to address the specific circumstances of any individual or entity. In specific circumstances, the services of a professional should be sought. Tax information, if any, contained in this communication was not intended or written to be used by any person for the purpose of avoiding penalties, nor should such information be construed as an opinion upon which any person may rely. The intended recipients of this communication and any attachments are not subject to any limitation on the disclosure of the tax treatment or tax structure of any transaction or matter that is the subject of this communication and any attachments.