PLR 1021045: Foundation's stock distribution is permitted and qualifies under sections 4942 and 4943

Plain-English summary

The IRS ruled for a private foundation that planned to receive voting, non-voting, and preferred stock from a trust. The foundation intended to distribute 80 percent of the voting stock to five supporting organizations and retain 20 percent, while keeping all of the non-voting common and preferred stock. The IRS concluded that the retained stock would not be excess business holdings if the foundation made the required distribution within five years, and that supermajority voting provisions would not change that result. It also concluded that the stock transfers to the supporting organizations would be qualifying distributions because the foundation would not control those organizations.

Ruling snapshot

• Question: Would the foundation's retained stock be permitted under section 4943, and would its stock transfers qualify under section 4942?
• Outcome: Approved
• Key authorities: IRC §§ 170, 4942, 4943, 501, 509, and 6110; Treas. Reg. §§ 53.4942(a)-3(a)(3), 53.4943-3(b)(1)(ii), and 53.4943-3(b)(2)

Full text (IRS public release)

DEPARTMENT OF THE TREASURY
INTERNAL REVENUE SERVICE
WASHINGTON, D.C. 20224

TAX EXEMPT AND
GOVERNMENT ENTITIES
DIVISION

Release Number: 201021045 Contact Person:
Release Date: 5/8/10
Date: March 2, 2010 Identification Number:
UIL Code:
4942.03-05 Telephone Number
4943.03-01
Employer Identification Number:

Legend:
L =

Company =
Trust =

Dear Sir or Madam:

This is in response to your request for rulings under sections 4942 and 4943 of the Internal
Revenue Code (“Code”) relating to your receipt and subsequent transfer of certain shares of
stock.

Facts

You are an organization described in section 501(c)(3) of the Code and classified as a private
foundation in section 509(a). You were created by L, who was the owner of all the
outstanding stock of Company. Company is a closely held corporation having four classes of
outstanding stock: voting common stock (the “Voting Common Stock”) and non-voting common
stock (collectively, the “Common Stock”); and two classes of non-voting preferred stock:
cumulative First Preferred Stock and non-cumulative Second Preferred Stock (collectively, the
“Preferred Stock’).

During his lifetime, L transferred all of his Common Stock and Preferred Stock to a
revocable trust (the “Trust”). The Declaration of Trust states that upon L’s death, the Trust
will distribute to you all the residue of the trust estate, which includes the Common Stock and
the Preferred Stock. L died in 2001.

The Declaration of Trust states that within five years after you receive the Voting Common
Stock from the Trust, you will retain 35 percent of the Voting Common Stock and will redistribute
65 percent of the Voting Common Stock equally to the five public charities identified in the
Declaration of Trust. The Declaration of Trust gives the trustees of the Trust broad discretion
with respect to the distribution of the Voting Common Stock. In pertinent part, the Declaration of
Trust states:

After the death of Grantor, the Trustees shall have broad discretion, exercisable by them at
any time and from time to time, with respect to the identity of the charitable recipients and the
amounts, nature and character of property distributed to each, including specifically the powers to

vary the percentages set forth in Schedule II to remove the entities specified in such Schedule in
whole or in part, to substitute or add other entities therefor or decline to do the same; provided,
however, that such organizations shall be described in Section 501(c)(3) and Section 509(a)(1),
(2) or (3) of the Internal Revenue Code and shall be organized and operated exclusively for such
purposes as are described in Section 501(c)(3) of the Code or to the federal government or to a
state or local government for such purpose.

Company’s Articles of Incorporation (“Articles”) state that only the holders of the Voting
Common Stock have the power to vote for the election of Directors. Holders are entitled to one
vote for each share held. Cumulative voting is not permitted. The Articles do not describe any
circumstances where the holders of the non-voting common stock would have the right to vote.
No additional shares of Common Stock may be issued without the unanimous consent of the
holders of 80 percent of the outstanding Voting Common Stock.

Company’s Articles state that the holders of the Preferred Stock do not have the right to vote,
except where the proposal is to amend the Articles to make any changes in the rights
associated with the Preferred Stock, or where a proposed merger or sale of assets would alter
the number of shares of Preferred Stock or change any of the rights associated with the
Preferred Stock.

As long as any shares of either class of Preferred Stock are outstanding, Company cannot,
without the consent of the holders of a majority of the outstanding shares of the particular class
of Preferred Stock, either (i) amend the Articles so as to make any changes that would
adversely affect the class of Preferred Stock outstanding, or (ii) merge Company or sell or lease
all or substantially all of its assets, unless the holders of the class of Preferred Stock
outstanding receive the same rights as before the transaction.

The Preferred Stock does not have any relative or special rights and powers other than as
described above. No shares of Preferred Stock may be issued without the unanimous consent
of the holders of 80 percent of the Voting Common Stock.

The Bylaws of Company state that Directors are elected by a simple majority vote. However, in
the case of the following extraordinary Company actions, the approval of 85 percent of the
outstanding voting shares (a “Supermajority”) is required:

1. Making a “fundamental change” as defined in the state’s business corporation
   law, or making a corporate distribution;

2. Issuing voting shares of Company;

3. Selling, transferring, or exchanging the rights to real property in excess of a
   certain value or percentage of current net assets of Company;

4. Acquiring a company or assets greater than a certain dollar value or percentage
   of Company's current net assets;

5. Changing the shareholder agreement; and

6. Changing this bylaw provision requiring a Supermajority vote.

There is no agreement between Company and the Trust that gives Company a right of first
refusal in the event a current or future shareholder of Voting Common Stock intends to sell or
otherwise transfer any of its Voting Common Stock.

In 2006, you formed five charitable organizations (the “Supporting Organizations”) solely for the
purpose of supporting five public charities (the “New Public Charities”). Some of the New Public
Charities are the same as and some are different from the public charities identified in the
Declaration of Trust. Each Supporting Organization is recognized as an organization described
in section 501(c)(3) of the Code and classified as a supporting organization under section
509(a)(3). The Bylaws of each Supporting Organization state that it will be operated to support
a specified New Public Charity (“Supported New Public Charity”) and that it “shall make grants
to support programs and further the purposes of the [Supported New Public Charity].” The
Bylaws of each Supporting Organization include conflicts of interest provisions.

The Bylaws of each Supporting Organization state that:

• It has seven directors, four of whom the Supported New Public Charity appoints and
  three of whom you appoint.

• Amending the Bylaws requires a majority vote of the Directors appointed by the
  Supported New Public Charity and a majority vote of the Directors you appoint.

• None of its Directors appointed by the Supported New Public Charity may be a family
  member of L or an employee of Company.

• To constitute a quorum, a majority of the Directors appointed by the Supported New
  Public Charity must be present.

• The officers are elected by the Directors appointed by the Supported New Public
  Charity.

Under the Declaration of Trust, when the trustees distribute to you the Voting Common Stock,
they will request that you retain 20 percent of the Voting Common Stock and distribute 80
percent of the Voting Common Stock to the five Supporting Organizations. Thus, you will retain
20 percent of the Voting Common Stock and will distribute 16 percent of the Voting Common
Stock to each of the five Supporting Organizations. In addition, you will retain all of Company’s
nonvoting common stock and all of its Preferred Stock.

Rulings Requested

1. Your ownership of Voting Common Stock will not constitute excess business holdings
   within the meaning of section 4943 of the Code, provided you distribute at least 80
   percent of the Voting Common Stock to the Supporting Organizations within the five-
   year period from the day the stock is distributed to you from the Trust.

2. The Supermajority requirements in Company's bylaws will not cause your ownership of
   Voting Common Stock to constitute excess business holdings within the meaning of
   section 4943 of the Code.

3. Your distribution of Voting Common Stock to the Supporting Organizations pursuant to
   the terms of the Trust will constitute a qualifying distribution under section 4942 of the
   Code.

Law

Section 4942 of the Code imposes an excise tax on the “undistributed income” of a private
foundation for a taxable year.

Section 4942(c) of the Code defines the term “undistributed income” as the excess of the
distributable amount for the taxable year over the “qualifying distributions” made from the
distributable amount.

Section 4942(g)(1)(A) of the Code defines the term “qualifying distribution” as any amount paid
to accomplish one or more purposes described in section 170(c)(2)(B) other than a contribution
to an organization controlled, directly or indirectly, by the foundation or disqualified persons with
respect to the private foundation.

Section 53.4942(a)-3(a)(3) of the Foundation and Similar Excise Taxes Regulations
(“regulations”) states that a donee organization is controlled by a private foundation, or by one
or more disqualified persons with respect to the foundation, if any such persons may, by
aggregating their votes or positions of authority, “require the donee organization to make an
expenditure, or prevent the donee organization from making an expenditure, regardless of the
method by which the control is exercised or exercisable.”

Section 4943 of the Code imposes excise taxes on the excess business holdings of any private
foundation in a business enterprise.

Section 4943(c)(1) of the Code provides that excess business holdings are the amount of stock
in a corporation a private foundation owns that exceeds its permitted holdings. Permitted
holdings are 20 percent of the corporation's voting stock less the percentage of the voting stock
owned by all disqualified persons.

Section 4943(c)(6) of the Code provides a five-year period during which a private foundation
may dispose of excess business holdings that it has acquired other than by purchase.

Section 53.4943-3(b)(1)(ii) of the regulations states that voting stock is determined by reference
to the power of stock to vote for the election of directors. The fact that extraordinary corporate
action (e.g., charter or by-law amendments) by a corporation may require the favorable vote of
more than a majority of the directors, or of the outstanding voting stock, of such corporation
shall not alter the determination of voting power of stock.

Section 53.4943-3(b)(2) of the regulations states that permitted holdings in a corporation include
non-voting stock held by the foundation where disqualified persons do not hold more than 20
percent of the voting stock of the corporation, and that all equity interests that do not have
voting power are classified as non-voting stock. In addition, stock with voting rights that will vest
only when conditions, the occurrence of which are indeterminate, have been met, such as
preferred stock which gains voting rights only if no dividends are paid, will be treated as non-
voting stock until the conditions have occurred that cause the voting rights to vest.

Analysis

Rulings No. 1 and 2

Under section 4943(c)(6) of the Code, you have five years from the date you receive the Voting
Common Stock from the Trust to dispose of sufficient Voting Common Stock to bring your
ownership of Voting Common Stock to the 20 percent level permitted under section 4943(c)(1).
Section 53.4943-3(b)(1)(ii) of the regulations states that voting stock is determined by reference
to the power of stock to vote for the election of directors. The fact that extraordinary corporate
action, such as charter or bylaw amendments, may require the favorable vote of more than a
majority of the directors, or of the outstanding voting stock, of such corporation does not alter
the determination of voting power of stock.

After you receive the distribution of Common Stock and Preferred Stock from the Trust, you
intend to distribute 80 percent of the Voting Common Stock to the Supporting Organizations by
distributing 16 percent to each of the five Supporting Organizations, and to retain 20 percent of
the Voting Common Stock, all of the non-voting common stock, and all of the Preferred Stock.

Company's Articles state that only the holders of the Voting Common Stock have the power to
vote for the election of Directors. Thus, the Supporting Organizations, which will own
collectively 80 percent of the Voting Common Stock, will together have the power to elect 80
percent of Company Directors, and you will have the power to elect 20 percent of Company
Directors. The Articles do not describe any circumstances where the holders of the non-voting
common stock would have the right to vote. The Articles expressly state that the holders of the
Preferred Stock do not have the right to vote, except in certain limited circumstances involving
the potential diminution of rights associated with the Preferred Stock.

Therefore, under the Articles, your ownership of the non-voting Common Stock and the
Preferred Stock does not give you any voting power with respect to the election of Company
Directors in addition to that which you already have through your ownership of 20 percent of the
Voting Common Stock. In addition, section 53.4943-3(b)(2) of the regulations provides that

stock having voting rights that will become effective only upon the occurrence of indeterminate
conditions will be treated as non-voting stock until the conditions have occurred. Thus, until any
of the conditions occur that would give the holders of Preferred Stock the power to vote, the
Preferred Stock will continue to be treated as non-voting stock for purposes of section 4943 of
the Code, and you will have no voting power with respect to the election of Company Directors
in addition to that which you already have through your ownership of 20 percent of the Voting
Common Stock.

The Bylaws of each Supporting Organization state that you appoint three of each organization’s
seven Directors and the Supported New Public Charity appoints four. The Bylaws also state
that amending the Bylaws requires a majority vote of the Directors elected by the Supported
New Public Charity and a majority vote of the Directors you appoint; that none of the Directors
of the Supporting Organization appointed by the Supported New Public Charity may be a family
member of L or an employee of Company; that to constitute a quorum, a majority of the
Directors of the Supporting Organization appointed by the Supported New Public Charity must
be present; and that the officers of each Supporting Organization are elected by the Directors
appointed by the Supported New Public Charity. Therefore, through your ability to appoint three
of the seven Directors of each Supporting Organizations, you will not have, either directly or
indirectly, any voting power with respect to the election of Company Directors in addition to that
which you already have through your ownership of 20 percent of the Voting Common Stock.

The Supermajority provisions of the Bylaws require that certain extraordinary Company actions
require a vote of 85 percent of the voting shares rather than a simple majority. After you
distribute 80 percent of the Voting Common Stock to the Supporting Organizations, your
ownership of 20 percent of the Voting Common Stock will enable you to prevent Company from
taking any of these actions. However, because none of these Company actions involves the
election of Company Directors, as a result of your power to block any of these actions, you do
not have, either directly or indirectly, any voting power with respect to the election of Company
Directors in addition to that which you already have through your ownership of 20 percent of the
Voting Common Stock. Section 53.4943-3(b)(1)(ii) of the regulations.

Accordingly, after you distribute 80 percent of the Voting Common Stock to the Supporting
Organizations by the end of the five-year period described in section 4943(c)(6) of the Code,
your ownership of the remaining 20 percent will constitute permitted holdings in Company within
the meaning of section 4943(c)(1) and section 53.4943-3(b)(1)(ii) of the regulations,
notwithstanding: (a) your ownership of all the non-voting common stock and all the Preferred
Stock of Company; (b) your power to appoint a minority of Directors of each of the Supporting
Organizations; and (c) the provisions in Company Bylaws relating to certain extraordinary
Company actions requiring Supermajority votes.

Ruling No. 3

A “qualifying distribution” for purposes of section 4942(c) of the Code does not include a
contribution to an organization controlled, directly or indirectly, by the private foundation or by a
disqualified person with respect to the private foundation. Section 4942(g)(1)(A). A donee
organization is controlled by a private foundation or by a disqualified person if such persons, by

aggregating their votes or positions of authority, may require or prevent the donee from making
an expenditure. Section 53.4942(a)-3(a)(3) of the regulations.

The Bylaws of each Supporting Organization state that of each organization’s seven Directors,
you appoint three and the Supported New Public Charity appoints four; that amending the
Bylaws requires a majority vote of the Directors elected by the Supported New Public Charity
and a majority vote of the Directors you elect; that none of the Directors of the Supporting
Organization appointed by the Supported New Public Charity may be a family member of L or
an employee of Company; that to constitute a quorum, a majority of the Directors of the
Supporting Organization appointed by the Supported New Public Charity must be present; and
that the officers of each Supporting Organization are elected by the Directors appointed by the
Supported New Public Charity. Consequently, you cannot amend a Supporting Organization’s
Bylaws without the consent of a majority of the Directors elected by the Supported New Public
Charity.

Therefore, under the Bylaws of each Supporting Organization, you do not have the power,
directly or indirectly, to require a Supporting Organization to make an expenditure or to prevent
it from making an expenditure. Accordingly, under section 4942(g)(1)(A) of the Code, you do
not control, directly or indirectly, any of the Supporting Organizations. As a result, your
distribution of the Voting Common Stock to each of the Supporting Organizations will not be
precluded from constituting a “qualifying distribution” within the meaning of section 4942(c).

Rulings

1. Your ownership of Voting Common Stock will not constitute excess business holdings
   within the meaning of section 4943 of the Code, provided you distribute at least 80
   percent of the Voting Common Stock to the Supporting Organizations within the five-
   year period from the day the stock is distributed to you from the Trust.

2. The Supermajority requirements in Company's bylaws will not cause your ownership of
   Voting Common Stock to constitute excess business holdings within the meaning of
   section 4943 of the Code.

3. Your distribution of Voting Common Stock to the Supporting Organizations pursuant to
   the terms of the Trust will constitute a qualifying distribution under section 4942 of the
   Code.

This ruling will be made available for public inspection under section 6110 of the Code after
certain deletions of identifying information are made. For details, see enclosed Notice 437,
Notice of Intention to Disclose. A copy of this ruling with deletions that we intend to make
available for public inspection is attached to Notice 437. If you disagree with our proposed
deletions, you should follow the instructions in Notice 437.

This ruling is directed only to the organization that requested it. Section 6110(k)(3) of the Code
provides that it may not be used or cited by others as precedent.

This ruling is based on the facts as they were presented and on the understanding that there will
be no material changes in these facts. This ruling does not address the applicability of any
section of the Code or regulations to the facts submitted other than with respect to the sections
described. Because it could help resolved questions concerning your federal income tax status,
this ruling should be kept in your permanent records.

If you have any questions about this ruling, please contact the person whose name and
telephone number are shown in the heading of this letter.

In accordance with the Power of Attorney currently on file with the Internal Revenue Service, we
are sending a copy of this letter to your authorized representative.

Sincerely,

Steven Grodnitzky

Manager

Exempt Organizations
Technical Group 1

Enclosure:
Notice 337