Rev. Rul. 81-22

1981-1 C.B. 510, 1981-3 I.R.B. 13.

                       Internal Revenue Service
                                 Revenue Ruling

                 PRIVATE FOUNDATIONS; EXCESS BUSINESS HOLDINGS

                          Published: January 19, 1981

26 CFR 53.4943-4: Present holdings

  Private foundations; excess business holdings. Section 4943(c)(4)(D) of the Code may limit a private foundation's permitted holdings in a business enterprise to 25 percent of the value of all outstanding shares of all classes of stock during the second phase of the present holdings rules described in section 4943(c)(4).

ISSUE

  Does section 4943(c)(4)(D) of the Internal Revenue Code, under the circumstances described below, limit the permitted holdings of a private foundation in a business enterprise to 25 percent of the value of all outstanding shares of all classes of stock of the business enterprise during the second phase of the present holdings rules described in section 4943(c)(4)?

FACTS

  On May 26, 1969, P, a private foundation described in section 509(a) of the Code, owed x shares of voting stock in corporation M representing 20 percent of the voting stock in M and 10 percent of the value of all outstanding shares of all classes of stock in M.  P also owned, on May 26, 1969, y shares of nonvoting stock in M, representing 20 percent of the value of all outstanding shares of all classes of stock in M.  A, the only disqualified person with respect to P, owned, on such date, x shares of voting stock in M, representing 20 percent of the voting stock in M and 10 percent of the value of all outstanding shares of all classes of stock in M.  M is a business enterprise as defined in section 4943(d)(4) and section 53.4943-10(a) of the Foundation Excise Tax Regulations.

  There were no transactions in M stock from May 26, 1969 through the end of the ten year first phase described in section 4943(c)(4)(B)(iii) of the Code.

LAW

  Section 4943(a)(1) of the Code imposes a tax on the excess business holdings of a private foundation equal to 5 percent of the value of such holdings.

  Section 4943(c)(1) of the Code states that the term "excess business holdings" means the amount of stock or other interest in a business enterprise that the foundation would have to dispose of to a person other than a disqualified person for its remaining holdings to be "permitted holdings."

  Section 4943(c)(2) of the Code provides generally that the permitted holdings of a private foundation are 20 percent (or 35 percent in appropriate cases) of the voting stock (or profits interest for partnerships or joint ventures, and in all other cases, beneficial interest) in a business enterprise reduced by the holdings of all of the foundation's disqualified persons.  In any case in which all disqualified persons together do no own more than 20 percent (or 35 percent in appropriate cases) of the voting stock of an incorporated business enterprise, nonvoting stock held by the private foundation shall also be treated as permitted holdings.

  Section 4943(c)(4) of the Code provides special transitional period rules in cases where the combined holdings of a private foundation and its disqualified persons in a business enterprise on May 26, 1969, exceed the 20 percent or 35 percent limitations of section 4943(c)(2).  With respect to such cases, section 4943(c)(4)(A) provides generally that the permitted percentage of business holdings will be equal to the combined holdings of the private foundation and its disqualified persons on May 26, 1969, subject to the limitation that such permitted percentage in any event will not exceed 50 percent.  Section 4943(c)(4)(A)(iii) specifically provides that the permitted percentages under sections 4943(c)(4)(A) and 4943(c)(4)(D) are to be applied both with respect to the voting stock of a corporation and, separately, with respect to the value of all outstanding shares of all classes of stock.

  Section 4943(c)(4)(B) of the Code provides that if, as of May 26, 1969, any interest of a private foundation constitutes excess business holdings (determined under the permitted percentages of section 4943(c)(2)), then all of the private foundation's holdings are treated as held by a disqualified person for a 20, 15, or 10 year period (the first phase).  Section 4943(c)(4)(B)(iii) provides that the 10 year first phase period applies when a private foundation and all disqualified person have a 75 percent or less voting stock interest and a 75 percent or less interest in the value of all outstanding shares of all classes of stock of a business enterprise on May 26, 1969.

  Section 4943(c)(4)(D) of the Code provides that if, at any time during the second phase, all disqualified persons together have

holdings in a business enterprise in excess of 2 percent of the voting stock of such enterprise, then the permitted percentage of section 4943(c)(4)(A) remains applicable during the second phase.  However, no more than 25 percent of the stock shall be voting stock held by the private foundation.  The second phase is the 15-year period immediately following the first phase.

  Section 53.4943-4(d)(5)(i) of the regulations provides that upon the expiration of the first phase with respect to an interest to which section 4943(c)(4) of the Code applies, such interest shall no longer be treated as held by a disqualified person under section 4943(c)(4)(B).  During the second phase, the manner of determining the permitted holdings of a private foundation to which section 4943(c)(4) applies shall be the same as applicable to the first phase, except that a 25 percent maximum shall apply under certain conditions specified in section 53,4943-4(d)(5)(ii).

  Section 53.4943-4(d)(5)(ii) of the regulations provides that if, or as soon as, the disqualified person voting level exceeds 2 percent after the expiration of the first phase, the permitted holdings of the private foundation shall not thereafter exceed 25 percent of the voting stock or 25 percent of the value of all outstanding shares of all classes of stock.

  Section 53.4943-4(d)(8)(i) of the regulations provides that since section 4943(c)(4) of the Code provides transitional rules for foundations which would otherwise have had excess business holdings on May 26, 1969, no holdings shall cease to be permitted holdings where such holdings would be permitted holdings under section 4943(c)(2).  Thus, for example, where the substituted combined voting level has been reduced to 20 percent (or 35 percent in appropriate cases), the provisions of section 4943(c)(2) concerning nonvoting stock as permitted holdings generally apply.

ANALYSIS

  Private Foundation P and its disqualified person, A, have combined holdings in M of 40 percent of the voting stock and 40 percent of the value of all outstanding shares of all classes of stock.  Since these percentages exceed the percentage limitations of section 4943(c)(2) of the Code, and the M stock was held by P and A on May 26, 1969, the present holdings rules of section 4943(c)(4) are applicable.  Thus, during the first phase, all of P's holding of M stock are treated as held by a disqualified person.

  Entering the second phase, P's holdings of M stock are no longer treated as held by a disqualified person.  Since A holds over 2 percent of the voting stock of M the special limitations of section 4943(c)(4)(D) of the Code and section 53.4943-4(d)(5)(ii) of the regulations are applicable.  Under these provisions, P's permitted holdings in M, at the beginning of the second phase, are limited to the lesser of the combined holdings of voting stock (40 percent) reduced by the disqualified person's holdings of voting stock (20 percent), or 25 percent of the voting stock.  Additionally, P's permitted holdings are further limited to the lesser of the combined holdings with respect to the value of all outstanding shares of all classes of M stock (40 percent) reduced by the disqualified person's holdings with respect to value (10 percent), or 25 percent of the value of all outstanding shares of all classes of M stock.

  Thus, at the beginning of the second phase, P's permitted holdings in M are 20 percent of the voting stock and 25 percent of the value of all outstanding shares of all classes of M stock.  Since P holds 30 percent of the value of all outstanding shares of all classes of the M stock, at the beginning of the second phase, P is in an excess business holdings position and is subject to the tax imposed by section 4943 of the Code.

  (i) Determination of permitted holding of voting stock:
  (a) Percentage of voting stock in M held by P on May 26, 1969  (percent) ------------ 20
    (b) Percentage of voting stock in M held by A on May 26, 1969  (percent) ------------ 20
  (c) Total holding of voting stock in M held by P and A on May 26, 1969 ((a) plus (b)) (percent) -------------------- 40
  (d) Permitted holding of voting stock by P in M (40 pct. less item (b) but no more than 25%) (percent) ----------- 20
  (ii) Determination of permitted holdings of value of all outstanding shares of all classes of stock:
  (a) Percentage of value of all M stock held by P on May 26, 1969  (percent) ------------ 30
  (b) Percentage of value of all M stock held by A on May 26, 1969  (percent) ------------ 10
  (c) total value of holdings in M by P and A on May 26, 1969 ((a) plus (b))  (percent) --- 40
    (d) Permitted holdings by P in M based on value of all M stock (40 pct. less item (b) but no more than 25 pct.) (percent) 25
  (iii) Determination of excess business holdings:
    (a) Percentage of voting stock in M held by P (percent) ----- 20
    (b) Permitted holdings of voting stock by P in M (percent) -- 20
    (c) Excess business holdings of P in M based on voting stock holdings ((a) less (b)) (percent) -------------------- 0
    (d) Percentage of value of all M stock held by P (percent) --- 30
    (e) Permitted holdings by P in M based on value of all M stock  (percent) ---------------- 25
    (f) Excess business holdings of P in M based on value of all M stock ((d) less (e)) (percent) 5
  The special rules relating to nonvoting stock of section 4943(c)(2) of the Code provide that if disqualified persons do not own more than 20 percent (or 35 percent in appropriate cases) of the voting stock of a corporation, then nonvoting stock held by a private foundation will be treated as permitted holdings.  If this rule were applicable in this case the y shares of nonvoting stock held by P would be permitted holdings because A holds no more than 20 percent of the M voting stock.  However, as provided in section 53.4943- 4(d)(8)(i) of the regulations, the permitted holdings rules under section 4943(c)(2) will be applicable in situations where holdings are initially subject to the present holdings rules under section 4943(c)(4) only if those holdings are reduced to the point where the combined voting stock holdings of the foundation and all disqualified persons do not exceed the 20 percent (or 35 percent in appropriate cases) limitations of section 4943(c)(2).  Since the combined holdings of P and A in the voting stock of M (40 percent) exceed the limitations of section 4943(c)(2), the nonvoting stock rule of section 4943(c)(2) would not apply in this case.

HOLDING

  Under the circumstances described above, section 4943(c)(4)(D) of the Code limits the permitted holdings of P to 25 percent of the value of all outstanding shares of all classes of stock of M during the second phase of the present holding rules described in section 4943(c)(4).

Rev. Rul. 81-22, 1981-1 C.B. 510, 1981-3 I.R.B. 13.