IRS approves a charitable lead trust's nonvoting interest in a note-holding LLC

Plain-English summary

A charitable lead unitrust was entitled to receive part of a revocable trust's residue, which included a promissory note owed by a disqualified person. A direct transfer of that note to the charitable trust would have created self-dealing. Instead, the revocable trust proposed contributing the note and cash to an LLC, giving the charitable trust only nonvoting interests, and distributing all voting interests to other beneficiaries in their individual capacities. The IRS concluded that the charitable trust would not control the LLC because it could not manage the company, select or remove its manager, compel distributions, or unilaterally dissolve it. The trust's receipt and ownership of the LLC interest, its proportionate distributions from note payments, and the LLC's enforcement or collection actions therefore would not be self-dealing. Because the LLC's sole ongoing asset was the interest-bearing note and at least 95 percent of its income would be passive, the LLC was not a business enterprise and the trust's interest would not create excess business holdings.

Ruling snapshot

• Question: Would the charitable lead trust's nonvoting LLC interest, related note-payment distributions, and continued ownership cause self-dealing or excess business holdings?
• Outcome: approved (the IRS ruled that the proposed structure would cause neither self-dealing nor excess business holdings)
• Key authorities: IRC §§ 512(b)(1), 4941, 4943, 4946, 4947(a)(2); Treas. Reg. §§ 53.4941(d)-1, 53.4941(d)-2(c), 53.4943-10

Full text (IRS public release)

 Internal Revenue Service                                      Department of the Treasury
                                                               Washington, DC 20224

 Number: 202037009                                             Third Party Communication: None
 Release Date: 9/11/2020                                       Date of Communication: Not Applicable
 Index Number: 4941.00-00, 4941.04-00,
               4943.00-00, 4943.03-00,                         Person To Contact:
               4943.04-03                                      ---------------------, ID No. -----------------

 ------------------------------------------------              Telephone Number:
 --------------------                                          -------------------
 ---------------------------                                   Refer Reply To:
                                                               CC:EEE:EOET:EO3
                                                               PLR-133620-18
                                                               Date:
                                                               June 17, 2019




Legend:

CLT                       = ------------------------------------------------
Decedent                  = --------------------
A                         = -------------------------
B                         = ---------------------------
C                         = ---------------------------
Corporation               = -----------------------------
Investment Trust          = ----------------------------------------------
Revocable Trust           = -------------------------------------------------

Dear ------------------------------------------------:

This letter responds to the letter dated November 7, 2018, in which CLT’s authorized
representative requested rulings under section 4941 and section 4943 of the Internal
Revenue Code (Code)1 regarding CLT’s receipt of a nonvoting interest in an LLC (LLC)
as well as distributions from LLC of a proportionate share of payments of principal and
interest from certain debt obligations held by LLC.

FACTS

Based on the documents and representations submitted, we construe the facts as
follows:

CLT was designed to qualify as a charitable lead unitrust, the charitable interest in
which is a right to receive a percentage of the net fair market value of the trust assets
that will vary as the value of the trust changes from year to year, distributed annually for

1 The Internal Revenue Code of 1986, as amended, to which all subsequent “section” references are

made unless otherwise indicated.
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a period of years to an organization described in sections 170(c), 2055(a), or 2522(a).
The remainder interests in CLT benefit certain of Decedent’s descendants. The trustees
of CLT are A, B, and C, all of whom are family members of Decedent within the
meaning of section 4946(d). CLT represents that it is subject to sections 4941 and 4943
pursuant to section 4947(a)(2).

During life, Decedent owned nonvoting shares in Corporation. Subsequent to acquiring
such shares, Decedent formed Investment Trust and sold nonvoting shares in
Corporation to Investment Trust in exchange for a promissory note (Note). The Note
evidenced Investment Trust’s obligation to pay Decedent interest annually for a period
of years with principal and all accrued and unpaid interest due at the end of the term of
the Note. CLT has represented that Investment Trust is a disqualified person with
respect to CLT.

As part of Decedent’s estate planning, Decedent executed a will and Revocable Trust.
Pursuant to the terms of Decedent’s will, upon Decedent’s death, the residuary of
Decedent’s estate, including the Note, passes to Revocable Trust. Revocable Trust
states generally that X percent of the residuary of Revocable Trust is to be distributed to
CLT.

At Decedent’s death, the Note became the property of Decedent’s estate while the
obligor of the Note continued to be Investment Trust. CLT has represented that an act
of self-dealing under section 4941 will result if the Note is directly transferred to CLT
because Investment Trust, a disqualified person with respect to CLT, is the obligor of
the Note and pursuant to the terms of Decedent’s will and the Revocable Trust
agreement, CLT may become the creditor of the Note.

CLT proposes that Revocable Trust form LLC and contribute cash and the Note to LLC
in exchange for 100% of LLC’s ownership interests, 99% of which are nonvoting
interests and 1% of which are voting interests. Revocable Trust will satisfy its
distribution obligations by distributing to CLT an amount of nonvoting interests in LLC
with a value equal to CLT’s full distribution entitlement. The remaining undistributed
nonvoting interests and all voting interests in LLC will be distributed to the other
Revocable Trust beneficiaries, A, B, and C in their individual capacities, and not as
trustees of CLT.

Pursuant to the LLC operating agreement, LLC will be managed by a single manager
(Manager) who is selected and may be removed by a vote of the members holding a
majority of the voting interests. The holders of the nonvoting interests will possess no
management rights or rights to vote on the appointment or removal of Manager. An
amendment to the LLC operating agreement or dissolution of the LLC requires the
approval of all members, whether holding voting or nonvoting interests.

LLC will hold and administer the Note and receive payments of interest and principal on
the Note. Aside from the cash initially contributed to LLC by Revocable Trust, LLC’s
PLR-133620-18                                 3

sole asset and source of income will be the Note. CLT will engage only in passive
investment activities, and not in the operation of any business enterprise. At least 95%
of CLT’s gross income will be from passive investments including interest and
dividends.

RULINGS REQUESTED

       1. The receipt from Revocable Trust and continued ownership by CLT of the
          interest in LLC will not be an act of self-dealing under section 4941.

       2. The receipt by CLT of distributions from LLC of a proportionate share of
          payments on the Note, and actions taken by LLC in connection with
          enforcement and collection of the Note, will not be an act of self-dealing under
          section 4941.

       3. The receipt from Revocable Trust and continued ownership by CLT of the
          interest in LLC will not result in excess business holdings under section 4943.

LAW

Section 512(b)(1) excludes dividends, interest, payments with respect to securities
loans (as defined in subsection (a)(5)), amounts received or accrued as consideration
for entering into agreements to make loans, and annuities, and all deductions directly
connected with such income from the calculation of unrelated business income tax.

Section 4941(a) imposes an excise tax on each act of self-dealing between a
disqualified person and a private foundation and on the participation of any foundation
manager, knowing that it is such an act.

Section 4941(d)(1)(B) defines self-dealing, in part, as including any direct or indirect
lending of money or other extension of credit between a private foundation and a
disqualified person.

Section 4943(a)(1) imposes an excise tax on the excess business holdings of any
private foundation in a business enterprise.

Section 4943(c)(1) defines the term “excess business holdings” in reference to a private
foundation, as the amount of stock or other interest in any business enterprise which the
foundation would have to dispose of to a person other than a disqualified person in
order for the remaining holdings of the foundation in such enterprise to be permitted
holdings.

Section 4943(d)(3) provides, in part, that the term “business enterprise” does not
include a trade or business at least 95 percent of the gross income of which is derived
from passive sources. It also provides that, for this purpose, gross income from passive
PLR-133620-18                                 4

sources includes certain items that are excluded from unrelated business income.
Among those items is interest that is excluded from unrelated business income by
section 512(b)(1).

Section 4946(a)(1) provides, in part, that the term “disqualified person” means, with
respect to a private foundation, a person who is –

       (A) a substantial contributor to the foundation,
       (B) a foundation manager (within the meaning of section 4946(b)(1)),
       (C) an owner of more than 20 percent of –
             (i) the total combined voting power of a corporation
             (ii) the profits interest of a partnership, or
             (iii) the beneficial interest of a trust or unincorporated enterprise, which is
             a substantial contributor to the foundation,
       (D) a member of the family (as defined in section 4946(d)) of any individual
           described in subparagraph (A), (B), or (C),
       (E) a corporation of which persons described in subparagraph (A), (B), (C), or
           (D) own more than 35 percent of the total combined voting power,
       (F) a partnership in which persons described in subparagraph (A), (B), (C), or
           (D) own more than 35 percent of the profits interest, and
       (G) a trust or estate in which persons described in subparagraph (A), (B), (C), or
           (D) hold more than 35 percent of the beneficial interest.

Section 4946(b)(1) defines the term “foundation manager” to include an officer, director,
or trustee of a private foundation.

Section 4947(a)(2) provides in part that, in the case of a trust which is not exempt from
tax under section 501(a), not all of the unexpired interests in which are devoted to one
or more of the purposes described in section 170(c)(2)(B), and which has amounts in
trust for which a deduction was allowed under sections 170, 545(b)(2), 652(c), 2055,
2106(a)(2), or 2522, certain Code provisions, including section 4941, shall apply as if
such trust were a private foundation.

Treas. Reg. § 53.4941(d)-1(b)(4) provides that a transaction between a private
foundation and an organization which is not controlled by the foundation (within the
meaning of subparagraph (5) of this paragraph), and which is not described in section
4946(a)(1)(E), (F), or (G) because persons described in section 4946(a)(1)(A), (B), (C),
or (D) own no more than 35 percent of the total combined voting power or profits or
beneficial interest of such organization, shall not be treated as an indirect act of self-
dealing between the foundation and such disqualified person solely because of the
ownership interest of such persons in such organization.

Treas. Reg. § 53.4941(d)-1(b)(5) provides, in part, 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,
PLR-133620-18                                 5

require the organization to engage in a transaction which if engaged in with the private
foundation would constitute self-dealing. For these purposes, an organization will be
considered to be controlled by a private foundation if the private foundation has the right
to exercise veto power over the actions of such organization relevant to any potential
acts of self-dealing.

In Treas. Reg. § 53.4941(d)-1(b)(8), Example (1), Private foundation P owns the
controlling interest of the voting stock of corporation X, and as a result of such interest,
elects a majority of the board of directors of X. Two of P’s foundation managers, A and
B, who are also directors of corporation X, form corporation Y for the purpose of building
and managing a country club. A and B receive a total of 40 percent of Y's stock, making
Y a disqualified person with respect to P under section 4946(a)(1)(E). In order to
finance the construction and operation of the country club, Y requested and received a
loan in the amount of $4 million from X. The example concludes that the making of the
loan by X to Y shall constitute an indirect act of self-dealing between P and Y.

Treas. Reg. § 53.4941(d)-2(c)(1) provides generally, 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. It further states that, generally, 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.

Treas. Reg. § 53.4943-10(a)(1) provides generally that the term “business enterprise”
includes the active conduct of a trade or business, including any activity which is
regularly carried on for the production of income from the sale of goods or the
performance of services and which constitutes an unrelated trade or business under
section 513.

Treas. Reg. § 53.4943-10(c) provides that the term “business enterprise” does not
include a trade or business at least 95 percent of the gross income of which is derived
from passive sources. For these purposes, gross income from passive sources
includes the items excluded by sections 512(b)(1) (relating to dividends, interest, and
annuities) and 512(b)(3) (relating to rent) and any income classified as passive for these
purposes does not lose its character merely because section 514 (relating to unrelated
debt-financed income) applies to such income. Stock in a passive holding company is
not to be considered a holding in a business enterprise even if the company is
controlled by the foundation. Instead, the foundation is treated as owning its
proportionate share of any interests in a business enterprise held by such company
under section 4943(d)(1).



ANALYSIS
PLR-133620-18                                 6

1.     Self-Dealing and the Receipt and Continued Ownership by CLT of the Interest in
       LLC

As a split-interest trust described in section 4947(a)(2), CLT is subject to the
requirements of section 4941 as if it were a private foundation.

A, B, and C are all disqualified persons with respect to CLT under section 4946(a)(1)(B)
as “foundation managers” because they are trustees of CLT. Accordingly, Investment
Trust is a disqualified person under section 4946(a)(1)(G) with respect to CLT because
it is a trust in which A, B, and C, who are all disqualified persons for the reasons stated
above, hold more than a 35 percent beneficial interest. As Investment Trust is the
obligor of the Note, an act of self-dealing would occur if Revocable Trust transferred the
Note to CLT, which would become creditor under the Note. See Treas. Reg. §
53.4941(d)-2(c)(1).

Instead, it is proposed that Revocable Trust will form LLC, transfer the Note to LLC for
voting and nonvoting interests, and transfer nonvoting interests in LLC to CLT. CLT will
acquire such nonvoting interests in LLC by gift rather than through a self-dealing
transaction; however, if CLT would be considered to “control” LLC within the meaning of
Treas. Reg. § 53.4941(d)-1(b)(5), then CLT would be considered to be the creditor,
indirectly, under the Note by reason of its ownership interest in LLC. See Treas. Reg. §
53.4941(d)-1(b)(8), Example (1).

CLT will not “control” LLC within the meaning of Treas. Reg. § 53.4941(d)-1(b)(5) due to
a lack of voting power. As holder of the nonvoting interests, CLT will have no
management rights or right to vote on the manager of LLC. The other beneficiaries of
Revocable Trust will own all of the voting interests, giving them the right to select and
remove the manager LLC. As a holder of nonvoting interests, CLT will have a right to
receive distributions only if LLC dissolves or chooses to make current distributions, but
the timing and amount of such distributions will be uncertain and cannot be compelled
by CLT. Only the other beneficiaries of Revocable Trust, as the holders of the voting
interests, may elect or remove the Manager, who will have the sole power to manage
the affairs of LLC and determine the timing and amount of distributions. Thus, CLT and
CLT’s trustees (acting only in such capacity) will not have sufficient votes or positions of
authority to cause LLC to engage in a transaction.

Additionally, CLT will not have the power to compel dissolution of LLC since LLC may
only be dissolved with written approval of all members, including the holders of the
voting interests. The power associated with the nonvoting interests of LLC as a
necessary party to vote on the liquidation of LLC is not considered equivalent to a “veto
power” within the meaning of Treas. Reg. § 53.4941(d)-1(b)(5) because the power
cannot be exercised over an action relevant to any potential act of self-dealing.
Consequently, CLT will not “control” LLC within the meaning of Treas. Reg. §
53.4941(d)-1(b)(5)
PLR-133620-18                                7

Accordingly, CLT’s receipt of nonvoting interests in LLC from Revocable Trust will not
constitute a loan or extension of credit between a “private foundation” and a
“disqualified person” within the meaning of section 4941(d)(1)(B) and Treas. Reg.
§53.4941(d)-2(c) because CLT will not acquire an interest in the promissory note;
instead, CLT will acquire nonvoting interests in LLC, with respect to which it will not
have any management rights or control over distributions.

Thus, CLT’s receipt and continued ownership of nonvoting interests in LLC will not
constitute an act of self-dealing described in section 4941.

2.     Self-Dealing and the Receipt of Distributions from LLC and Actions Taken by
       LLC in Connection with Enforcement and Collection of the Note

Under Treas. Reg. § 53.4941(d)-1(b)(4), a transaction between a private foundation and
an organization does not result in an act of self-dealing where the organization is neither
controlled by the foundation nor does it have a disqualified person owning at least a
35% beneficial interest in the organization. Here, as explained above, CLT does not
control LLC because CLT only holds nonvoting interests, with the only voting interests in
LLC held by the other Revocable Trust beneficiaries. Although the other Revocable
Trust beneficiaries may be trustees of CLT and thus disqualified persons, they own the
voting interests in LLC in their individual capacities and not as foundation managers of
CLT. Further, the other Revocable Trust beneficiaries only own an approximately 1%
beneficial interest in LLC, below the 35% threshold.

3.     Excess Business Holdings

LLC’s sole asset will be the Note, which will generate passive income in the form of
interest, as described in sections 4943(d)(3) and 512(b)(1). As such, LLC will not be
considered a “business enterprise” for purposes of section 4943(d)(3) because at least
95 percent of its gross income will derive from passive sources. See also Treas. Reg. §
53.4943-10(c)(1). Because LLC will not be considered a “business enterprise,” the
restrictions on excess business holdings under section 4943 will not apply. Thus, CLT’s
receipt and continued ownership of nonvoting interests in LLC will not result in excess
business holdings under section 4943.

CONCLUSION

Based solely on the facts and representations submitted by CLT, we rule as follows:

1. The receipt from Revocable Trust and continued ownership by CLT of the interest in
LLC will not be an act of self-dealing under section 4941.

2. The receipt by CLT of distributions from LLC of a proportionate share of payments on
the Note, and actions taken by LLC in connection with enforcement and collection of the
Note, will not be an act of self-dealing under section 4941.
PLR-133620-18                                  8


3. The receipt from Revocable Trust and continued ownership by CLT of the interest in
LLC will not result in excess business holdings under section 4943.

The rulings contained in this letter are based upon information and representations
submitted by or on behalf of CLT and accompanied by a penalty of perjury statement
executed by an appropriate party, as specified in Rev. Proc. 2019-1, 2019-1 I.R.B. 1,
§ 7.01(16)(b). This office has not verified any of the material submitted in support of
the request for ruling, and such material is subject to verification on examination. The
Associate Office will revoke or modify a letter ruling and apply the revocation
retroactively if: (1) there has been a misstatement or omission of controlling facts; (2)
the facts at the time of the transaction are materially different from the controlling facts
on which the ruling is based; or (3) the transaction involves a continuing action or
series of actions and the controlling facts change during the course of the transaction.
See Rev. Proc. 2019-1, § 11.05.

No ruling is granted as to whether CLT qualifies as an organization described in
section 501(c) or section 509(a). Except as expressly provided above, no opinion is
expressed or implied concerning the federal income, estate, gift, or foundation excise
tax consequences of any aspects of any transaction or item of income described in this
letter ruling.

This ruling will be made available for public inspection under section 6110 after certain
deletions of identifying information are made.

This letter is directed only to CLT. Section 6110(k)(3) provides that it may not be used
or cited as precedent.
PLR-133620-18                                  9

In accordance with the Power of Attorney on file with this office, a copy of this letter is
being sent to CLT’s authorized representatives.

                                       Sincerely,



                                       Don R. Spellmann
                                       Senior Counsel
                                       Exempt Organizations Branch 3
                                       Associate Chief Counsel
                                       (Employee Benefits, Exempt Organizations, and
                                       Employment Taxes)




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