On Feb. 9, President Trump signed into law the Philanthropic Enterprise Act of 2017 as part of budget legislation. The new law, which took effect Dec. 31, 2017, allows private foundations to own 100 percent of a business under these conditions:
1. The foundation must own 100 percent of the shares. There cannot be any other shareholders, and the shares must have been donated to the foundation or acquired in some manner other than by purchase.
2. All profits must go to charity. The company has to distribute 100 percent of its net operating income to the foundation within 120 days of the end of each fiscal quarter.
3. The for-profit company is operated independently of the foundation. First, no substantial donor to the foundation can be a director, officer, or employee of the company. Second, a majority of the company’s directors have to be persons who are not also on the foundation’s board. Finally, the company may not make loans to substantial donors of the foundation.
4. Donor-advised funds and some supporting organizations cannot take advantage of the new law.
The new law opens a world of possibilities for founders of companies that want to permanently devote all profits from their businesses to charity.
One way to adopt this model is to have the founder or the shareholders donate their shares to a foundation. They get a tax deduction for the value of their shares, but no buyout. Since this is a gift, not a purchase, donating the shares satisfies the requirements of the new rule. The donations can happen anytime or even over time, but the new rule does not apply until 100 percent of the shares have been transferred to the foundation.
Under the new law, a total separation of the two entities is not required. The for-profit company will continue to be governed by its own board and managed by its own managers, with appropriate separation from the foundation. The new law permits the foundation, as the sole shareholder, to appoint the board, and the foundation may also hold other rights, depending on the jurisdiction where it was formed. For example, in many states, a sole shareholder has the right to inspect the books and records of the company and to sue the directors for breach of fiduciary duty (including the duty to pursue a social mission, if the company is a benefit corporation.) The shareholder may also reserve to itself the right to approve mergers, sales of assets, dissolutions, and to veto other fundamental decisions.
Profits of the business will be up-streamed to the foundation in the form of after-tax corporate dividends or, in the case of a pass-through LLC, as partnership distributions, in which case the tax on unrelated business income may apply.
We are sure to see a growing number of private foundations take ownership of profitable businesses as a result of this new law. It also offers another option for founders of mission-oriented companies who want a philanthropic exit that locks mission into the company on a permanent basis.
Allen Bromberger is a partner at Perlman & Perlman. Through his legal practice, and as an author and lecturer, Allen has been at the forefront of fourth sector and social enterprise movements that have risen to prominence in recent years.