Will LLCs change the face of philanthropy? Not if philanthropic donors continue to value current tax benefits.December 11, 2015
Recent Zuckerberg-Chan LLC Announcement. On December 1, 2015, Mark Zuckerberg and his wife Priscilla Chan announced that they would give 99% of their Facebook shares during their lifetimes to charitable purposes. To facilitate this plan, they formed a new organization, the Chan Zuckerberg Initiative LLC. The choice of an LLC entity—rather than a private foundation—was surprising. However, an LLC structure can provide flexibility and control to a donor, at the sacrifice of income tax benefits.
An LLC is Flexible. An LLC can be controlled by its founders, undertake virtually any legal activity, and can be updated and restructured frequently, without many limitations. But that control and flexibility comes at a cost. Contributions to a private LLC are not tax deductible as charitable donations, even if the LLC is formed to support a philanthropic cause. (Note that if an LLC makes a donation to a qualified charitable entity, a charitable tax deduction may be passed through to the LLC’s members).
Private Foundations are Limited. A private foundation is subject to numerous restrictions and other requirements. A private foundation is:
- Limited in the voting percentage it can hold in a business enterprise;
- Limited in the types of investment activities it can undertake;
- Limited in the amount of compensation it can pay;
- Limited in the types of grants it can make;
- Required to make minimum annual distributions, regardless of investment returns; and
- Prohibited in engaging in some activities, including political and lobbying activities, transactions involving foundation insiders (e.g., the Gates Foundation could never pay rent to a company owned by Bill Gates, even if the rent was set at below-market value) and for-profit business activities.
Flexibility Valued for the Facebook Gift. Zuckerberg admits that an LLC structure provides more flexibility for Chan and him to pursue philanthropic goals in ways that may not be considered charitable by the IRS. On December 4, 2015, Zuckerberg posted to Facebook: “The Chan Zuckerberg Initiative is structured as an LLC rather than a traditional foundation. This enables us to pursue our mission by funding non-profit organizations, making private investments and participating in policy debates–in each case with the goal of generating a positive impact in areas of great need. Any net profits from investments will also be used to advance this mission. By using an LLC instead of a traditional foundation, we receive no tax benefit from transferring our shares to the Chan Zuckerberg Initiative, but we gain flexibility to execute our mission more effectively.”
Hypothetical Examples of an LLC Response versus a Foundation Response. To illustrate the potential flexibility of an LLC structure, Appendix A, below, has a few hypothetical situations and describes how a domestic LLC and a private foundation might respond to each. These hypothetical situations are intended only to illustrate the potential flexibility of an LLC structure compared to a private foundation and do not cover all legal aspects of the situation.
For Some Philanthropists, Tax Benefits are Secondary. Zuckerberg and Chan’s announcement is unlikely to change the face of philanthropy, but the publicity around their LLC may prompt other charitable-minded individuals to take a second look at the LLC structure. This is particularly the case for donors that have a relatively low adjusted gross income (“AGI”) compared to their overall wealth because the charitable tax deduction is limited to a percentage of AGI. (This is likely the case for Zuckerberg and Chan, as Zuckerberg’s salary at Facebook is only $1). The LLC structure may also be attractive for younger individuals who are viewing their lifetime philanthropic efforts over a long-time horizon, as they recognize that some issues will call for solutions with a public policy or political factor in addition to traditional charitable efforts.
Conclusion. An LLC provides greater flexibility and control, but at a significant cost (i.e., the loss of tax benefits that would otherwise apply to a charitable gift). For a donor that is interested in pursuing a multi-faceted approach to thorny issues, an LLC can provide the flexibility to fund both charitable solutions and public policy and political efforts. For a donor interested in current tax benefits, a private foundation or other charitable vehicle, such as a donor advised fund or supporting organization, may be a better choice. However, the tax benefits of a foundation come at a price, including the loss of flexibility and control.
Appendix A: Hypothetical Illustrations
Hypothetical #1: An earthquake hits in the Fiji Islands regions. Thousands are suddenly homeless and need medical supplies and other help.
Foundation Response: The foundation wants to provide a grant to help with the earthquake disaster. To avoid red tape, the foundation must locate a charity (not a private group) to accept and administer the grant. If the grantee is outside of the United States, then the foundation must determine that the foreign grantee is equivalent to a U.S.-based public charity in the way it is organized and operated, likely through the opinion of an accountant or attorney. If the foundation does not make an equivalency determination, the foundation must follow an “expenditure responsibility” process (more red tape). The grant must be restricted to charitable purposes. The foundation may not be able to fund all the types of assistance that are needed. While some needs in the earthquake region are clearly charitable (providing food and medical supplies to families displaced by the earthquake), other needs may not be so clearly charitable (such as loaning money or investing in a small business so that it can re-open after the quake). Since the foundation’s grant may only support charitable purposes, the foundation may need the help of an attorney or other qualified advisor to determine the types of activities it can fund to help after the earthquake. Given all this red tape, it may take the foundation some time to set up the grant and direct assistance to where it is needed. The foundation’s grant will also be disclosed publicly on its Form 990-PF filing.
LLC Response: The LLC can immediately send help to the earthquake region, even if the funding or assistance is not deemed charitable by IRS guidelines. The LLC may still need the assistance of an attorney or advisor in complying with local and international laws, but the LLC could likely respond more quickly than the foundation. The LLC has no public disclosure responsibilities for the grant. However, unless the LLC makes grants to qualified U.S. charities, the LLC will not receive a charitable tax deduction to pass through to its members.
Hypothetical #2: An extremely bright orphan has overcome many obstacles, shows a promising mind for science, and deserves a scholarship. The student also has legal custody of his minor brother and he and his brother need help with living, transportation and childcare expenses while the student attends school.
Foundation Response: The foundation would need to seek advance approval from the IRS for a scholarship program in order to provide a grant to the orphan. The scholarship would be limited to funding qualified educational expenses and the foundation would be limited in funding other living expenses for the student. The foundation’s grant will be disclosed publicly on its Form 990-PF filing.
LLC Response: The LLC can fund a scholarship for the student as well as help the student with his other expenses so that the student can attend school and also support his minor brother. The LLC has no public disclosure responsibilities for the grant. However, unless the LLC makes grants to qualified U.S. charities, the LLC will not receive a charitable tax deduction to pass through to its members.
Hypothetical #3: A promising medical researcher has discovered a new development that may lead to a cure for cancer. The medical researcher starts up a for-profit company to help develop and market her discovery. She is seeking millions of dollars for investments in her company to help fund the expensive research necessary to bring her product to market. The risk-reward potential is very high, and the investment in the company is not expected to pay off or be liquid for several years.
Foundation Response: The foundation may not be able to invest in the company due to (i) the excess business holdings limitation (limiting the voting percentage the foundation can hold of any for-profit company), (ii) the jeopardizing investment prohibition (which prohibits risky investments that may not be prudent for the foundation), or (iii) the annual distribution requirements (which require the foundation to have sufficient liquid assets to meet its annual distribution requirements). If the foundation is able to make an investment within the private foundation rules, the foundation’s investment will be publicly disclosed on its Form 990-PF.
LLC Response: The LLC can invest as much as it wants into the researcher’s company. There are no public disclosure obligations under tax regulations for the LLC’s investment in the company. The LLC will not receive a charitable tax deduction to pass through to its members for its investment in a for-profit company.
Hypothetical #4: A philanthropist donated her favorite painting to a charitable enterprise she founded, but now she has a new vacation home and wants to display the painting in the home. No other painting in the world matches the décor so perfectly.
Foundation Response: The founder is probably out of luck. The painting can’t be transferred or sold back to the founder (even at many times its value), due to the self-dealing limitations. The founder also can’t display the painting in her private vacation home because the painting is now a charitable asset. The founder’s family is limited in the same way, so they can’t buy or display the painting either. The founder’s only comfort is that she received a charitable tax deduction for donating the painting for charitable purposes.
LLC Response: The LLC can transfer the painting back to the founder or loan it for display. Some paperwork may be necessary, but the founder can generally control what happens to the painting even while it is held by the LLC. The founder never received a charitable tax deduction, however.
Hypothetical #5: It is the year 2550 and humanity needs to relocate from a dilapidated Earth to Mars, stat. Congress is in political deadlock and the funding that is needed from the U.S. to complete Mars terraforming efforts are inaccessible due to a lockbox law that was passed by a prior Congress. Oddly, Congress has not passed any new tax laws since 2015, so the laws governing foundations and LLCs are the same as today.
Foundation Response: The Foundation cannot participate in a political solution, such as by funding advocacy efforts or candidates. The Foundation may fund terraforming projects through charitable grants, but the Foundation’s efforts will be limited to funding activities that are considered charitable by the IRS.
LLC Response: The LLC structure is flexible to allow the LLC to participate in a policy solution. Subject to local and national campaign finance laws, the LLC can (i) fund the campaigns of candidates that promise to carry out the U.S. terraforming obligation; (ii) directly or indirectly fund grassroots lobbying efforts to help inform the public and Congress and initiate public policy change; and (iii) directly or indirectly hire a lobbyist to work for changes by Congress or state legislatures on the terraforming issue. The LLC will not be entitled to a deduction for expenditures on political or lobbying activities.
To view a general comparison of LLCs and private foundations, please click here.
This is a general client alert and is not legal or financial advice.
For more information on philanthropic foundations or LLCs, please contact Wendy Richards or any team member of our tax or estate planning teams at 414-273-3500.