Supporting organization's business holdings were exempted from excise tax

Plain-English summary

A Type III non-functionally integrated supporting organization owned a development project that would become an excess business holding when statutory transition periods expired. The organization had tried to sell the project, but a financing problem delayed a potential purchaser and the approaching tax deadline weakened the organization's negotiating position. The state attorney general concluded that a forced below-market sale would seriously harm the community and the organization's charitable beneficiaries. Based on those facts, the organization's plan to sell as soon as possible, and its commitment to continue meaningful distributions, the IRS exempted the project interest from the § 4943 excess business holdings tax.

Ruling snapshot

• Question: Could the supporting organization's interest in the development project be exempted from the excess business holdings tax under § 4943(f)(2)?
• Outcome: approved
• Key authorities: IRC §§ 501, 509(a)(3), and 4943; Pension Protection Act of 2006

Full text (IRS public release)

Internal Revenue Service                                      Department of the Treasury
                                                              Washington, DC 20224

Number: 201645011                                             Third Party Communication: None
Release Date: 11/4/2016                                       Date of Communication: Not Applicable
Index Number: 4943.00-00
                                                              Person To Contact:
---------------------------------------------------------     ------------------------------, ID No. ------------
---------------------------------------                       -----------------
---------------------------------------------------           Telephone Number:
---------------------------------                             ----------------------
                                                              Refer Reply To:
                                                              CC:TEGE:EOEG:EO3
                                                              PLR-119906-16
                                                              Date:
                                                              August 09, 2016


LEGEND

Foundation                             =     ---------------------------------------------------------
State                                  =     -------------------
Supported Organizations                =     ------------------------------------------------------------------------
Development Project                    =     ------------------------------------------------------
Company 1                              =     ------------------------------------------------------------------------
                                             ------------------------------------------------------------------------
                                             -----------------
Company 2                              =     -----------------------------------------------------------------------
Attorney General                       =     -----------------------------------------------------------------
Year 1                                 =     -------
Date 1                                 =     ----------------------
Date 2                                 =     ----------------------
Date 3                                 =     -----------------
Date 4                                 =     -----------------------


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

This is in response to a letter from the Foundation’s authorized representatives dated
June 17, 2016, and subsequent correspondence on the Foundation’s behalf requesting
a ruling exempting the Development Project from application of the excess business
holdings tax pursuant to the Secretary’s authority under section 4943(f)(2) of the
Internal Revenue Code (the “Code”).1




1
 The Internal Revenue Code of 1986, as amended, to which all subsequent “section” references are
made unless otherwise indicated.

PLR-119906-16                                2

FACTS

The Foundation is a trust formed under the laws of State. The Internal Revenue
Service has recognized the Foundation as an organization described in section
501(c)(3) and classified it as a Type III non-functionally integrated supporting
organization described in section 509(a)(3). The Foundation represents that it has
traditionally made grants in excess of 3.5 percent of its net asset value to its Supported
Organizations.

In Year 1, the Foundation invested in the Development Project, a business enterprise
within the meaning of section 4943(d)(3), as a 70 percent owner through Company 1
and Company 2, both of which are disregarded entities for federal tax purposes
(collectively, the “Companies”). The Foundation owns 100 percent of the membership
interest in the Companies, which own, indirectly through a series of subsidiaries, the
assets of the Development Project.

On Date 1, the Foundation’s ownership in the Development Project (through the
Companies) increased to 100 percent as the result of a redemption transaction.

Between Year 1 and Date 1, Congress passed the Pension Protection Act of 2006, Pub.
L. No. 109-280, 120 Stat. 780 (2006) (the “PPA”), which applied the excess business
holding rules of section 4943 to Type III supporting organizations (other than
functionally integrated Type III supporting organizations). Transition rules provided
Type III supporting organizations a number of years to dispose of excess business
holdings held on August 17, 2006 (the date of the PPA’s enactment), or, in certain
circumstances, obtained subsequently. The Foundation represents that, if it continues
to hold 100 percent of the Development Project, it will have excess business holdings
beginning August 17, 2016, with respect to the 70 percent interest it held upon the Act’s
enactment and on Date 2 with respect to its 30 percent interest obtained as a result of
the redemption.

The Foundation represents that, shortly after the PPA’s enactment, it began planning to
dispose of its excess business holdings in the Development Project. Although the
redemption on Date 1 increased the Foundation’s excess business holdings, this
transaction improved the Foundation’s ability to sell the Development Project. The
Foundation states that it has entered into numerous negotiations to sell, and has
entertained various offers to purchase, the Development Project.

Currently, the Foundation is in late-stage negotiations with a potential purchaser.
However, an unanticipated problem with the proposed financing is impacting the
purchaser’s ability to close the sale. Additionally, the purchaser recently discovered that
the Foundation is faced with an imminent deadline to dispose of all or part of the
Development Project and is using this information as leverage to obtain a below-market
price for the project. The Foundation is unsure whether the sale will close prior to

PLR-119906-16                                 3

August 17, 2016, if at all, because of the Development Project’s value and the
complexity of the transactions and organizational structure. The Foundation states that
a forced sale of the Development Project at a below-market price will cause it to suffer
serious financial consequences and losses. In particular, the Foundation represents
that its support of its Supported Organizations would decrease as a result of its
endowment’s decline in value.

On Date 3, the Foundation obtained a letter from the State Attorney General, who has
jurisdiction over the Foundation, concluding that a forced sale of the Development
Project would have a severe detrimental impact on the Foundation’s community. The
Attorney General reached this conclusion after discussing the issues at length with the
Foundation’s leaders, charitable beneficiaries, and other interested persons. The State
Attorney General’s letter provides additional detail:

      One specific example of such detriments includes reduced funding for
      [certain] schools. This would result in layoffs and firings of teachers,
      administrators and staff. Thus, many individuals would become
      unemployed or underemployed. It would result in fewer and leaner
      scholarships, causing a considerable impact on the public’s access to
      higher education, including students from [State].

      Furthermore, the Foundation’s support for [certain] charitable
      organizations would decline, resulting in less charitable activity in the
      community, less support to needy organizations in [State] and elsewhere,
      and less involvement of [State] residents in these activities. Many of
      [these] organizations, including the schools, give back to the local
      communities. With funds from the Foundation, the purchase and donate
      much needed household supplies, food, and educational resources such
      as books and school supplies to those in need.

      Many individuals and organizations within and without [State] depend on
      the support of the Foundation. This includes members of [certain]
      churches and congregations in [State]. These local individuals and groups
      rely and depend on the resources of the Foundation, and a reduction in
      those resources would place a severe strain on their viability in [State]. . . .

      We do not believe that requiring the Foundation to increase its funding
      above what is required under the Internal Revenue Code is necessary at
      this time, especially in light of the fact that the Foundation has distributed
      more than what it was required to distribute for many, many years. The
      current level of funding is designed to allow the Foundation to exist in
      perpetuity. Most studies of endowments for situations similar to the
      Foundation’s situation suggest that distributions in the range of 3.5

PLR-119906-16                                 4

       percent to 4.5 percent of assets would allow the Foundation to continue in
       perpetuity.

       In closing, we feel strongly that if the Foundation were forced to dispose of
       its . . . investments in a detrimental way in order to avoid the impending
       federal taxes, there would be a severe detrimental economic and non-
       economic impact on [certain communities in State] as well as on the
       residents of, and organizations within, [State] and other states.

The Foundation requests a ruling that, pursuant to the Secretary’s authority in section
4943(f)(2), its interest in the Development Project is exempt from the tax on excess
business holdings because such holdings are consistent with the purpose or function
constituting the basis for the Foundation’s exemption under section 501(a).
Nonetheless, the Foundation represents that it has no intention of holding the
Development Project and proposes to sell it as quickly as possible but, in any case,
prior to Date 4. The Foundation also proposes to continue making meaningful
distributions to its Supported Organizations and, when possible, to make distributions in
excess of the required amount.

LAW

Section 501(a) of the Code provides generally that an organization described in section
501(c) is exempt from federal income taxes.

Section 501(c)(3) provides that an organization organized and operated exclusively for
any of various specified charitable purposes is referred to in section 501(a), but only if it
also satisfies other stated requirements that are not relevant to this analysis.

Section 509(a)(3) excludes from the term “private foundation” an organization which –

   (A) Is organized, and at all times thereafter is operated, exclusively for the benefit of,
       to perform the functions of, or to carry out the purposes of one or more specified
       organizations described in section 509(a)(1) or (2) (commonly referred to as
       “public charities”),
   (B) Is –
           (i) Operated, supervised, or controlled by one or more public charities,
           (ii) Supervised or controlled in connection with one or more such
                 organizations, or
           (iii) Operated in connection with one or more such organizations, and
   (C) Is not controlled directly or indirectly by one or more disqualified persons (as
       defined in section 4946) other than foundation managers and other than one or
       more or more public charities.

PLR-119906-16                                 5

Section 4943(f)(5)(A) defines the term “Type III supporting organization” as an
organization that meets the requirements of section 509(a)(3)(A), (B)(iii), and (C).

Section 4943(f)(5)(B) defines the term “functionally integrated Type III supporting
organization” as a Type III supporting organization which is not required under
regulations established by the Secretary to make payments to its supported
organizations (as defined in section 509(f)(3)) due to the activities of the organization
related to performing the functions of, or carrying out the purposes of, such supported
organizations.

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

Section 4943(c)(1) provides that the term “excess business holdings” means, with
respect to the holdings of any private foundation in any business enterprise, the amount
of stock or other interest in the 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(c)(2)(A) provides that the permitted holdings of any private foundation in
an incorporated business enterprise are 20 percent of the voting stock reduced by the
percentage of the voting stock owned by all disqualified persons.

Section 4943(f)(1) and (f)(3)(A) provides for the application of the excise tax on excess
business holdings to a section 509(a)(3) Type III supporting organization (other than a
functionally integrated Type III supporting organization) as if it was a private foundation.
Section 4943(f)(5) provides that rules similar to the rules of section 4943(c)(4), (5), and
(6) apply to organizations described in section 509(a)(3) with certain modifications. In
particular, section 4943(c)(4)(A)(i) modifies section 4943(b)(2) to permit Type III non-
functionally integrated supporting organizations to hold up to 50 percent of the voting
stock of an incorporated business enterprise if the supporting organization and all
disqualified persons together had excess business holdings in such enterprise in excess
of 20 percent of the voting stock on August 17, 2006 (the date of the enactment of the
Pension Protection Act of 2006, Pub. L. No. 109-280, 120 Stat. 780 (2006) (the “PPA”)).
However, section 4943(c)(4)(B)(iii) provides that, any interest in a business enterprise
held on August 17, 2006, if the supporting organization on such date has excess
business holding, shall (while held by the supporting organization) be treated as held by
a disqualified person (rather than by the supporting organization) during the 10-year
period beginning on such date, in any case in which the supporting organization holds
less than 75 percent of the voting stock. Additionally, section 4943(c)(6)(A) provides
that, if after August 17, 2006, there is a change in the holdings of in a business
enterprise (other than by purchase by the supporting organization or a disqualified
person) which causes the supporting organization to have excess business holdings in
such enterprise, the interest of the supporting organization in such enterprise

PLR-119906-16                                6

(immediately after such change) shall (while held by the supporting organization) be
treated as held by a disqualified person (rather than by the supporting organization)
during the 5-year period beginning on the date of such change in holdings. Additionally,
section 4943(c)(6)(B) provides that, if after August 17, 2006, there is a change in the
holdings of in a business enterprise (other than by purchase by the supporting
organization or a disqualified person) which causes the supporting organization to have
an increase in excess business holdings in such enterprise (determined without regard
to section 4943(c)(6)(A)), section 4943(c)(6)(A) shall apply, except that the excess
holdings immediately preceding the increase therein shall not be treated, solely
because of such increase, as held by a disqualified person (rather than by the
supporting organization).

However, section 4943(f)(2) provides that the Secretary may exempt the excess
business holdings of a supporting organization from the application of the excess
business holdings tax if the Secretary determines that such holdings are consistent with
the purpose or function constituting the basis for its exemption under section 501.

When reviewing a request for exemption under section 4943(f)(2), the legislative history
indicates that the Secretary should consider the views of the State attorney general, as
well as any additional factors that the staff of the Joint Committee on Taxation might
enumerate in its Technical Explanation of the PPA. Additionally, the legislative history
suggests that the Secretary may also consider as additional factors, whether the shares
held by donors and related persons are controlling or whether donors and related
persons are bound to ultimately contribute all but a de minimis amount of shares to the
organization and have no direct or indirect control over the organization and its
investments. See 152 Cong. Rec. S8754 – S 8755 (Aug. 3, 2006).

In its Technical Explanation, the staff of the Joint Committee on Taxation listed the
following factors that the Secretary should consider in making its determination: (1) a
reasoned determination by the State attorney general with jurisdiction over the
supporting organization that disposition of the holdings would have a severe detrimental
impact on the community; and (2) a binding commitment by the supporting organization
to pay out at least five percent of the value of the organization’s assets each year to its
supported organizations. A reasoned determination would require, among other things,
evidence that any such determination was made pursuant to a serious study by the
State attorney general of the issues involved in disposing of the excess holdings, and
findings by the State attorney general about the detrimental economic impact that would
result from such disposition. If, as a result of such State attorney general’s study and
findings, the State attorney general directed as a matter of State law that permission of
the State would be required prior to any sale of the holdings, such a factor should be
given strong consideration by the Secretary. Technical Explanation of H.R. 4, the
“Pension Protection Act of 2006,” as Passed by the House on July 28, 2006, and as
Considered by the Senate on August 3, 2006 (JCX-38-06) at 361.

PLR-119906-16                                7

ANALYSIS

The IRS has classified the Foundation as a Type III non-functionally integrated
supporting organization. The Foundation (through the Companies) held 70 percent of
the Development Project, a business enterprise within the meaning of section
4943(d)(3), on August 17, 2006. Furthermore, the Foundation’s interest in the
Development Project increased to 100 percent on Date 1 as the result of a redemption
transaction. Accordingly, the Foundation has excess business holdings. However, as
represented by the Foundation, under the transition rules, the Foundation has until
August 17, 2016, and Date 2, respectively, to dispose of its excess business holdings.
See section 4943(c)(4)(B)(iii), (c)(6), & (f)(5). Nonetheless, section 4943(f)(2) provides
that the Secretary may exempt the excess business holdings of a supporting
organization from the excess business holdings excise tax if the Secretary determines
that such holdings are consistent with the purpose or function constituting the basis for
the organization’s exemption under section 501.

The State Attorney General concluded that a forced sale of the Development Project by
the Foundation would have a severe economic and non-economic impact on the
Foundation’s community, as well as on the residents of, and organizations within, the
State. Additionally, the Foundation proposes to continue making meaningful
distributions and, when possible, to make distributions in excess of the required amount.
Finally, the Foundation states that it has no intention of retaining its interest in the
Development Project and proposes to sell it as soon as possible, in any event, by Date
4.

RULINGS

Based on the facts and circumstances and the legislative history of the PPA, and
assuming the accuracy of the facts and representations set forth herein, we rule that,
pursuant to the Secretary’s authority under section 4943(f)(2), the Foundation’s interest
in the Development Project is exempt from the excess business holding excise tax
imposed by section 4943.

The rulings contained in this letter are based upon information and representations
submitted by or on behalf of the Foundation (accompanied by a penalty of perjury
statement executed by an individual with authority to bind the Foundation) and upon the
understanding that there will be no material changes in the facts. This office has not
verified any of the material submitted in support of the request for rulings, and such
material is subject to verification on examination.

No ruling is granted as to whether the Foundation qualifies as an organization described
in section 501(c) and/or section 509(a).

This ruling does not address the applicability of any section of the Code or Regulations

PLR-119906-16                                  8

to the facts submitted other than with respect to the sections specifically described, and,
except as expressly provided in this letter, no opinion is expressed or implied
concerning the federal income tax consequences of any aspects of any transaction or
item of income set forth above.

Because it could help resolve questions concerning federal income tax status, this ruling
should be kept in the Foundation’s permanent records.

A copy of this letter must be attached to any tax return to which it is relevant.
Alternatively, if the Foundation files its return electronically, this requirement may be
satisfied by attaching a statement to the return that provides the date and control
number of this letter.

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

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

This letter is directed only to the Foundation. Section 6110(k)(3) provides that it may
not be used or cited as precedent by anyone else.

For any questions about this letter, please contact the person whose name and
telephone number are shown in the heading.

Sincerely,




Don R. Spellmann
Senior Counsel, Exempt Organizations Branch 3
(Tax Exempt & Government Entities)