Chief Counsel Memo Recommends PF Excise Taxes and Revocation
IRS veteran super heroes, Chris Hyde and Ward Thomas, have written a painstakingly clear and airtight Chief Counsel Memorandum concluding that two spouses who were the sole trustees of a private foundation they founded and operated are liable for self-dealing and jeopardizing investment excise taxes, and that the private foundation’s tax-exempt status should be revoked because it operated for private benefit. The two caped tax avengers concluded along the way that the managers’ clumsy attempt to correct the transactions were insufficient. They penned the memorandum last summer but it was released just last Friday. Here is a distilled summary of the facts:
A married couple created a private foundation and funded it with appreciated stock. No doubt they deducted the full fair market value as charitable contributions. The spouses served as the foundation’s only trustees and officers. The husband pretty much made all the financial and management decisions. Husband owned more than 35% of the stock of a separate corporation but less than 35% interest in a separate LLC taxed as a disregarded entity. Over a period of about 15 years, the Husband caused the foundation to loan amounts almost equal to the foundation’s entire net worth to the corporation and LLC. Husband thoroughly owned and controlled the corporation and LLC but must have thought that since he owned less than 35% of the LLC, the transaction would not trigger a self-dealing or any other excise tax. The loans were made over several years and appeared to coincide with the corporation and LLC’s operating capital needs. The loans called for balloon payments and in many years, the debtors failed to even make interest payments.
For the first seven years of the audited period, Husband owned more than 35% of the corporation’s stock. After seven years, husband’s interest in the corporation decreased to less than 35% and after 15 years, he sold the company altogether. In year 13, the spouses acquired 100% of the LLC. In an attempt to avoid a self-dealing excise tax on the still outstanding loan to the LLC, the husband decided that he would donate the LLC note to a public charity so that the Foundation would not be the creditor on a loan to a 35% owned entity. Unfortunately, and apparently unbeknownst to the husband, the donation never occurred leaving the Foundation holding the note on a loan to the managers’ then 100% owned company.
The managers apparently understood that loans to a 35% owned company constituted self-dealing. The memo doesn’t indicate why the husband made loans to the corporation anyway. The husband, perhaps on the advice of his tax advisor, thought the loans to the LLC would not be self-dealing if the Foundation rid itself of the note before he and his wife acquired 100% of the LLC. Hence, the failed attempt to donate the note to a public charity (which probably would not have enforced the note anyway). Also, the husband signed on behalf of both creditor and debtors for all loans and at some point, the loans were modified to extend the length and reduce the interest rates.
As noted earlier, the memo takes the reader – in this case, my former Pitt Law student Casey Lothamer (Mid-Atlantic Area Counsel, TE/GE) – painstakingly through the statutes, regulations and applicable case law to conclude thusly:
We conclude that: (1) the loans cause the Foundation to be operated for the private benefit of the foundation manager and associated business entities; (2) the loans are indirect acts of self-dealing under section 4941(d)(1)(E); (3) the proposed transfer of the promissory notes would not constitute correction within the meaning of section 4941(e)(3); and (4) modification of the promissory notes resulted in jeopardizing investments under section 4944.
Imposition of excise taxes and revoking a private foundations tax exempt status is a relatively rare thing. This memorandum provides an excellent overview and case study.
darryll k. jones