Foundation may retain nonvoting LLC units without indirect self-dealing

Plain-English summary

An individual planned to transfer a nonvoting interest in a disregarded LLC to a private foundation after the individual and spouse had died. The LLC's sole asset was a note from the individual's daughter, and the LLC would earn interest from that note. The IRS concluded that the foundation's receipt and retention of nonvoting units, and its receipt of passive income from the LLC, would not be direct or indirect self-dealing under section 4941 because the foundation would receive the units by gift and would lack control over the LLC. The ruling did not express an opinion on section 4943 or the estate-administration exception under the regulations.

Ruling snapshot

• Question: Would the foundation's retention of nonvoting LLC units after the survivor's death constitute indirect self-dealing?
• Outcome: Approved, subject to the stated facts and conditions.
• Key authorities: IRC §§ 4941 and 4946; Treas. Reg. §§ 53.4941(d)-1 and 53.4941(d)-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: 201407023 Contact Person:
Release Date: 2/14/2014
Date: November 18, 2013 Identification Number:

UIL: 4941.00-00
Telephone Number:

Social Security Number:

Legend:

Taxpayer

LLC

Foundation

Dear

This is in response to your letter dated March 20, 2013 in which you requested a ruling with respect to § 4941 of the Internal Revenue Code (“Code”).

Background:

You are an individual. After the death of the later to survive of you or your wife, your estate plan stipulates that an ownership interest in LLC will go to Foundation, a private foundation founded by you, as discussed below.

You made capital contributions to and currently own all of the membership units, voting and nonvoting, of LLC, a Limited Liability Company, which is a disregarded entity for federal income tax purposes. LLC is managed by the members owning voting units (Managing Members). A Managing Member's signature is sufficient to bind LLC. Managing Members are authorized to invest or reinvest available funds in investments consistent with the purposes of LLC, to vote any stock or other voting security, to exercise the rights of a general partner, to expend LLC funds to borrow as they deem appropriate, to collect obligations payable to LLC, and to generally perform the duties of running LLC. Managing Members will also make distributions from time to time in such amounts as they decide after considering the needs of LLC and their fiduciary obligations to all members. All distributions will be made to all unit holders, voting and nonvoting, ratably in proportion to ownership of units. These rights and responsibilities are designated solely to the Managing Members. LLC may only be dissolved with the written approval of members holding at least fifty percent of the units in each member class, voting and nonvoting.

The sole asset of LLC is a note from your daughter. The only income derived by LLC will be income from the note. Taxpayer represents that LLC is engaged solely in passive investment activities and does not engage in, and will not be engaged in, the operation of any business enterprise. The promissory note from your daughter bears interest at the long-term federal rate determined under § 1274(d) in effect at the time you and your daughter entered into the agreement. The principal of the note is due at the end of the note’s term. This note will continue to be an asset of LLC, and the interest therefrom will be LLC’s sole income. You propose to transfer at death a non-voting interest of LLC to Foundation, but not a voting interest, through either your or your wife’s estate. LLC will have multiple owners and will not be a disregarded entity.

Rulings Requested:

The distribution from the asset holders and retention by Foundation of non-voting units in LLC following the death of the survivor of you and your wife will not constitute indirect acts of self-dealing pursuant to § 53.4941(d)-1(b)(5)-(b)(6), and accordingly, will not violate § 4941 even though LLC’s sole assets will be the note and income generated by the note.

Law:

I.R.C. § 4941(d)(1) defines self-dealing as the sale or exchange, or leasing, of property between a private foundation and a disqualified person as well as the lending of money or other extension of credit between a private foundation and a disqualified person.

I.R.C. § 4946(a)(1) provides that a “disqualified person,” with respect to a private foundation, includes a substantial contributor, as defined under section 507(d)(2), a foundation director or officer, and any spouse, ancestor, child, grandchild, great grandchild, and any spouse of a child, grandchild, or great grandchild of that contributor, director, or officer.

Treas. Reg. § 53.4941(d)-1(b)(5) provides that an organization is controlled by a private foundation if the foundation or one or more of its foundation managers (acting only in such capacity) may, only by aggregating their votes or positions of authority, require the organization to engage in a transaction which if engaged in with the private foundation would constitute self- dealing. Similarly, for purposes of this paragraph, an organization is controlled by a private foundation in the case of such a transaction between the organization and a disqualified person, if such disqualified person, together with one or more persons who are disqualified persons by reason of such a person's relationship to such disqualified person, may, only by aggregating their votes or positions of authority with that of the foundation, require the organization to engage in such a transaction. The “controlled” organization need not be a private foundation.

Treas. Reg. § 53.4941(d)-2(c) provides that, “the lending of money or other extension of credit between a private foundation and a disqualified person shall constitute an act of self-dealing. Thus, for example, an act of self-dealing occurs where a third party purchases property and assumes a mortgage, the mortgagee of which is a private foundation, and subsequently the third party transfers the property to a disqualified person who either assumes liability under the mortgage or takes the property subject to the mortgage. Similarly, except in the case of the receipt and holding of a note pursuant to a transaction described in § 53.4941(d)-1(b)(3), an act of self-dealing occurs where a note, the obligor of which is a disqualified person, is transferred by a third party to a private foundation which becomes the creditor under the note.”

Revenue Ruling 76-158, 1976-1 C.B. 354, A private foundation, owning thirty-five percent of the voting stock of a corporation and having a foundation manager personally owning the remaining sixty-five percent but not holding a position of authority in the corporation by virtue of being foundation manager, does not control the corporation for purposes of the self-dealing provisions of § 4941.

Analysis:

Section 53.4941(d)-1(a) of the regulations states that “the term ‘self dealing’ means any direct or indirect transaction described in § 53.4941(d)-2. Section 53.4941(d)-2 describes five specific acts of self-dealing: (1) sale or exchange of property; (2) leases; (3) loans; (4) furnishing goods, services, or facilities; and (5) transfer or use of the income or assets of a private foundation. Section 53.4941(d)-2(c) provides that an act of self-dealing occurs when a note, the obligor of which is a disqualified person, is transferred by a third party to a private foundation which becomes the creditor under the note.

If the option holders fail to exercise their option after your death, LLC will retain ownership of the note payable by your daughter, and Foundation will own nonvoting units in LLC. Both LLC and your daughter are disqualified persons as to Foundation. Section 4946(a)(1). Foundation's retention of a nonvoting interest in the LLC and its receipt of passive income from LLC, however, will not constitute any of the acts of self-dealing described in § 4941(d)(1) or § 53.4941(d)-2. The arrangement between the LLC and Foundation will neither be a loan nor an extension of credit. Section 53.4941(d)-2(c). Foundation would acquire nonvoting units in LLC by gift, rather than through a self-dealing transaction. As a holder of nonvoting units, Foundation will have a right to receive distributions only if LLC dissolves or it chooses to make current distributions, but the timing and amount of such distributions would be uncertain, and could not be compelled by Foundation. The Managing Members, holders of voting units, are given sole power to manage the affairs of LLC and determine the timing and amount of distributions. Additionally, Foundation cannot compel dissolution of LLC since it requires the vote of a holder of fifty percent of the voting units in addition to its own.

Foundation will not have “control” over LLC (as defined in § 53.4941(d)-1(b)(5)) due to the lack of voting power to manage or operate LLC. We do not consider the power associated with the non voting interest in LLC as a necessary party to vote on the liquidation of the LLC to be the equivalent of a “veto power’ within the meaning of section 53.4941(d)-1(b)(5) in that the other attributes of that interest lack any other powers with respect to operation and management. Furthermore, the liquidation of LLC in this context could result in a self-dealing problem for Foundation. Therefore, the retention by LLC of your daughter’s note following your death would not be an act of direct or indirect self-dealing between Foundation and one or more disqualified persons under § 53.4941(d)-1 or § 4941.

Ruling:

The distribution from the your estate, your revocable trust, or your wife’s estate, whichever

holds the asset prior to distribution, and retention by Foundation of non-voting units in LLC following the death of the survivor of you and your wife will not constitute indirect acts of

self-dealing pursuant to § 53.4941(d)-1(b)(5)-(b)(6), and accordingly, will not violate § 4941 even though LLC’s sole assets will be the note and income generated by the note.

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 individual that requested it. Additionally, this ruling is directed solely to the sections mentioned and no opinion is expressed on the effects of § 4943 or the estate administration exception under § 53.4941(d)-1(b)(3). 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 resolve 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,

Ronald Shoemaker
Manager, Exempt Organizations
Technical Group 2

Enclosure
Notice 437