Gift of nonvoting LLC interests to charitable trust avoided self-dealing

Plain-English summary

A trust creator planned to give a charitable lead annuity trust nonvoting interests in an LLC whose only assets were promissory notes owed by trusts for descendants. Those note obligors were disqualified persons, so a direct transfer of the notes would have been self-dealing. The IRS found that the charitable trust would not control the LLC because it could not manage the LLC, choose its manager, compel distributions, or dissolve it without the voting member's consent. The trust therefore would not be treated as an indirect creditor on the notes, and the gift of nonvoting interests would not be direct or indirect self-dealing under § 4941.

Ruling snapshot

• Question: Would an irrevocable gift of nonvoting LLC interests holding notes from disqualified persons constitute self-dealing?
• Outcome: Approved. The trust lacked control of the LLC and would not acquire the notes directly or indirectly.
• Key authorities: IRC §§ 4941, 4946, and 4947; Treas. Reg. §§ 53.4941(d)-1 and 53.4941(d)-2

Full text (IRS public release)

Internal Revenue Service Department of the Treasury
Washington, DC 20224

Number: 201907004 Third Party Communication: None
Release Date: 2/15/2019 Date of Communication: Not Applicable
Index Number: 4941.00-00, 4941.04-00,
4946.00-00, 4946.01-00, Person To Contact:
4947.00-00 -------------------------, ------------------
Telephone Number:
----------------------------- ----------------------
----------------------------- Refer Reply To:
------------------------------------ CC:TEGE:EOEG:EO1
----------------------------------------- PLR-117315-18
Date:
November 08, 2018

Trustor = ------------------------------
Trust = -----------------------------------------------------------------------------
LLC = --------------
State = --------------
LLC 2 = ------------------
Daughter = ----------------------------

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

This letter responds to a letter from Trustor’s authorized representative dated May 15,
2018, and subsequent correspondence requesting a ruling that Trustor’s proposed
lifetime irrevocable transfer to Trust of the nonvoting interests in LLC, the only assets of
which are promissory notes from disqualified persons described in section
4946(a)(1)(G) of the Internal Revenue Code,1 will not violate the prohibition against self-
dealing under section 4941.
Trust represents the facts as follows:

1
Section 4946(a)(1)(G) of the Internal Revenue Code of 1986, as amended, to which all subsequent
section references are made unless otherwise stated.
PLR-117315-18 2

FACTS

Trustor transferred certain business interests to trusts established for the benefit of
Trustor’s descendants (Beneficiary Trusts) in exchange for promissory notes that pay
interest only for a term of 30 years, with the total principal amount due at the end of the
term. The sole beneficiary or all of the beneficiaries of each Beneficiary Trust are
Trustor’s descendants.

Trustor assigned the promissory notes to LLC, a State limited liability company. The
members of LLC are Trustor, who holds all of the nonvoting interests in LLC, and LLC 2,
which holds all of the voting interests in LLC. The members of LLC 2 are Trustor’s
descendants and each holds interests as individuals.

LLC will hold and administer the promissory notes and receive payments of interest and
principal on the promissory notes. Aside from the cash initially contributed by LLC 2 for
the voting interests in LLC (which will fund LLC expenses), LLC’s sole assets and
source of income will be the promissory notes.

Power to manage the affairs of LLC is vested in the manager, who is selected and may
be removed by a vote of the members holding at least a majority of the voting interests
in LLC (currently LLC 2, which holds 100 percent of such voting interests). Daughter,
who is also the trustee of Trust, is the initial manager of LLC. Daughter holds interests
in LLC only in an individual capacity indirectly through her interests in LLC 2, not in her
capacity as trustee of Trust.

The members holding nonvoting interests (currently Trustor, who holds 100 percent of
such nonvoting interests) possess no management rights or rights to vote on who will
be the manager of LLC. LLC may be dissolved only with written approval of all
members, whether holding voting or nonvoting interests.

Trust is a charitable lead annuity trust (CLAT) within the meaning of Rev. Proc. 2007-
45, the charitable interest in which is a right to a guaranteed annuity, distributed
annually to a public charity that is described in section 501(c)(3). The remainder
interests benefit Trustor’s descendants. Trustor proposes to fund Trust by transferring
Trustor’s nonvoting interests in LLC to Trust. The annuity amount shall be paid from
Trust’s income, including distributions from LLC, and, to the extent income is
insufficient, from Trust’s principal. Trustor represents that Trust is subject to section
4941 under section 4947(a)(2).

LAW

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.
PLR-117315-18 3

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 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(a)(2) provides that the term “substantial contributor” means a person who
is described in section 507(d)(2) (i.e., a person who contributed or bequeathed an
aggregate amount of more than $5,000 to the private foundation if such amount is more
than 2 percent of the total contributions and bequests received by the foundation before
the close of the taxable year of the foundation in which the contribution or bequest is
received by the foundation from such person; and, in the case of a trust, the creator of
the trust).

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 section 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)(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
PLR-117315-18 4

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. 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) restates the general rule under section 4941(d)(1)(B)
that, generally, 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.

ANALYSIS

As a split-interest trust described in section 4947(a)(2), Trust is subject to the
requirements of section 4941 as if it were a private foundation. Trustor is a disqualified
person under section 4946(a)(1)(A) with respect to Trust as a “substantial contributor”
because Trustor is the creator of Trust. Daughter is a disqualified person under section
4946(a)(1)(B) with respect to Trust as a “foundation manager.”

Beneficiary Trusts are disqualified persons under section 4946(a)(1)(G) with respect to
Trust because they are trusts in which Trustor’s descendants, who are disqualified
persons under section 4946(a)(1)(D) with respect to Trust, hold more than a 35-percent
beneficial interest. Beneficiary Trusts are the obligors of promissory notes given to
Trustor in exchange for certain business interests. An act of self-dealing would occur if
Trustor transferred the promissory notes to Trust, which would become creditor under
the notes. See Treas. Reg. §53.4941(d)-2(c)(1).

Instead, Trustor assigned the promissory notes to LLC and proposes to transfer
nonvoting interests in LLC to Trust. Trust will acquire the nonvoting interests in LLC by
gift rather than through a self-dealing transaction. However, if Trust would be
considered to “control” LLC within the meaning of Treas. Reg. §53.4941(d)-1(b)(5), then
PLR-117315-18 5

Trust 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).

As holder of the nonvoting interests, Trust will have no management rights or right to
vote on the manager of LLC. LLC 2 will own all of the voting interests, giving LLC 2 the
right to select and remove the manager LLC. As a holder of nonvoting interests, Trust
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 could
not be compelled by Trust. Only LLC 2, as the holder of the voting interests, may elect
or remove the manager of LLC, and such manager will have the sole power to manage
the affairs of LLC and determine the timing and amount of distributions. Thus, Trust
and Trust’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, Trust will not have the power to compel dissolution of LLC since LLC may
only be dissolved with written approval of all members, including LLC 2. 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, Trust will not “control” LLC
within the meaning of Treas. Reg. §53.4941(d)-1(b)(5)

Accordingly, Trust’s receipt of nonvoting interests in LLC from Trustor 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
Trust will not acquire an interest in the promissory note; instead, Trust will acquire
nonvoting interests in LLC, with respect to which it will not have any management rights
or control over distributions.

Thus, Trustor’s proposed transfer of nonvoting interests in LLC to Trust will not
constitute an act of self-dealing described in section 4941.

CONCLUSION

Based solely on the facts and representations submitted, we rule that Trustor’s
proposed irrevocable transfer to Trust of the nonvoting interests in LLC, the only assets
of which are promissory notes from disqualified persons described in section
4946(a)(1)(G), will not constitute an act of direct or indirect self-dealing under section
4941.

The ruling contained in this letter is based upon information and representations
submitted by the taxpayer and accompanied by a penalty of perjury statement executed
by an appropriate party, as specified in Rev. Proc. 2018-1, 2018-1 I.R.B. 1,
§7.01(16)(b). We have not verified any of the material submitted in support of the
PLR-117315-18 6

request for a 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. 2018-1, §11.05.

No ruling is granted as to whether Trust qualifies as an organization described in Rev.
Rul. 2007-45. No opinion is expressed regarding the valuation of any assets described
in this ruling request for estate or gift tax purposes. Except as expressly provided
above, no opinion is expressed or implied concerning the federal income, estate, gift, or
foundation excise tax consequences of any other 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 ruling is directed only to the taxpayer requesting it. Section 6110(k)(3)
provides that it may not be used or cited as precedent.

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

                                               Sincerely,


                                               _______________________________

                                               Theodore Lieber
                                               Senior Tax Law Specialist
                                               Exempt Organizations Branch 1
                                               Associate Chief Counsel
                                               (Tax Exempt and Government Entities)

cc: