Tax The Chan Zuckerberg Initiative: LLC for Philanthropy Adding flexibility but not tax savings, the use of an LLC rather than a private foundation for philanthropic efforts should not be controversial.

This article was originally published in the March 2016 edition of Estate Planning magazine. by Michael Kosnitzky

In December 2015, and Priscilla Chan announced an innovative type of philanthropic initiative. Perhaps never before, however, have people been so vilified for pledging to give away most of their net worth. The expression “no good deed goes unpunished” does not even begin to explain the way that the Chan Zuckerberg Initiative (CZI) and Priscilla Chan and her husband Mark Zuckerberg have been treated by some members of the press and academia.

Never in the history of mankind have two people pledged to do so much to Michael Kosnitzky advance human potential and promote equality and have been treated so Tax harshly for it. Perhaps some explanations are in order, however, as even some +1.786.913.4884 fair-minded individuals have gotten the technical aspects of the CZI planning [email protected] wrong. For purposes of simplicity, Ms. Chan and Mr. Zuckerberg are referred to in the discussion that follows as “the Zuckerbergs.” Michael Kosnitzky is a partner in Pillsbury’s Tax practice, resident in the law firm’s New Pledge rather than immediate gift York and Miami offices. His practice includes The Zuckerbergs’ commitment to give 99% of their shares (worth representation of both domestic and foreign about $45 billion) is a pledge. It is not an outright current gift, donation, high-net-worth individuals and corporations, investment, or expenditure. The Zuckerbergs agreed to spend their money over partnerships, limited liability companies, S time and have made a very public commitment to do so. corporations, and real estate investment trusts.

Pledging cash or property to a charity is a very common practice. A pledge means that the pledger intends to perform in the future when the money is actually needed by the charity or when a specific event occurs—such as attaining a commitment letter for construction of a building, the hiring of a new CEO, or even the death of the pledger.

The law governing the enforceability of pledges by charities against pledgers is well-settled. As a general rule, these pledges are not enforceable, meaning a pledge to a charity is only as good as the word of the person making the pledge. An exception applies, however, when the charity detrimentally relies on the pledge, which means that a particular charity incurred expenses or obligations specifically because of the pledger’s promise to donate and the pledger knew this and that the charity would be irreparably damaged if the pledger did not perform on his or her pledge. This is no different in substance than what the Zuckerbergs have done here except that their pledge, unlike the pledge of

Optional label for Practice when there is no Bio info included. Pillsbury Winthrop Shaw Pittman LLP pillsburylaw.com Tax Tax most people to a specific charity, was Likewise, the LLC’s expenditures will tax deduction could be taken. In that offered more broadly, quite publically, flow through to the Zuckerbergs for tax situation, the increased benefit of and with great fanfare thereby purposes only when the LLC actually the deduction taken at a higher tax creating even greater assurance donates cash or Facebook stock to a rate could be greater than the time that the Zuckerbergs will perform charity, makes a gift to an individual, value of money benefit of taking the lest they be subject to great public or expends funds for other purposes deduction in an earlier year. If the ridicule or, in contemporary parlance, (e.g., lobbying for causes consistent Zuckerbergs were to make contribu- pubic “shaming” via social media and with the LLC’s business purpose). The tions of cash or stock today to either the Internet. Zuckerbergs will receive the exact same public charities (generally churches, tax treatment with respect to these schools, hospitals, governmental Tax effect of entity selection items of income and gain and expendi- entities, private operating foundations, The Zuckerbergs will continue to tures as they would have received had and other nonprofit entities organized own indirectly the Facebook stock they recognized the income and gain, for charitable, religious, educational, contributed to the limited liability or paid the expenditures directly and scientific, or literary purposes) or to company (LLC) until either it or not through the LLC. Nothing about an their own private foundation, instead the proceeds of its sale are donated LLC changes the way the Zuckerbergs of using an LLC, they would be to a charity, gifted to an individual, will be taxed. entitled to a current tax deduction invested in a for-profit company, against their income for the year the or used to pay lobbying or other contributions were made that could expenditures. This probably puts The LLC model does afford also be carried forward, if not fully them in a worse tax position than had greater flexibility for lobbying used, and applied against future they just donated some of the shares income for a maximum of five years.1 to a combination of public charities and for-profit activities than Once contributions are made to these and a private foundation. the charitable model. charities, and a current tax deduction taken by the Zuckerbergs, public A domestic LLC is treated as charities would be under absolutely a “flow-through entity” for most For instance, if the LLC makes a contri- no obligation to immediately deploy tax purposes. This means that an bution to a charity of cash or Facebook the funds or stock contributed by the LLC’s tax attributes flow through stock at some time in the future, the Zuckerbergs for charitable purposes. to its owners, who are in this case Zuckerbergs would at that time be Instead, the charity could decide not the Zuckerbergs. At present, the entitled to a tax deduction subject to to use the funds for its charitable primary asset of the LLC will be the various statutory limitations (some purposes until many years later. Facebook stock, so the Zuckerbergs of which are addressed below). While will continue to be responsible for the tax treatment would be the same In the case of a contribution to a any taxes associated with dividends regardless of whether the LLC was ever private foundation, the only obligation paid by the company on the shares formed, many of the strategies deployed would be to make the mandatory and gains from the sale of the shares in tax planning however are based annual distribution of 5% of the by the LLC, if any are in fact sold. on time value of money principles. value of its endowment2 but even Dividends, however, are unlikely to This means that tax professionals use this can be minimized in several be paid now or in the foreseeable techniques designed to accelerate ways. For example, besides grants future by the company because of the deductions so that they can be used to or contributions to other charities company’s focus on growth investing, reduce current taxes. The principle is for charitable purposes, reasonable and the ongoing requirement to pay simple: A tax deduction taken now is administrative expenses necessary for dividends would reduce the financial better than one taken later. the conduct of the charitable activities flexibility of the company. Facebook’s of the foundation itself, costs of all website, under Investor Relations, One important exception to this direct charitable activities, amounts clearly states that “Facebook does not proposition, not relevant here, is if paid to acquire assets used directly pay a dividend.” tax rates are expected to substantially in carrying out charitable purposes increase in a future year when the (such as computers, office furniture,

Pillsbury Winthrop Shaw Pittman LLP The Chan Zuckerberg Initiative: LLC for Philanthropy or an office building), assets set aside While the LLC model does afford for charitable purposes and program- greater flexibility for lobbying Charitable contribution related investments and loans, are all and for-profit activities than the deduction limits treated as qualifying distributions for charitable model, it is less tax efficient The ability of the Zuckerbergs to this purpose. While these charitable than the charitable model in making receive the benefits of a charitable organizations do have limitations on grants to individuals because in the contribution tax deduction at any their ability to lobby, these restrictions former case, such grants would be time is curtailed by the various are not absolute and they can use their treated as taxable gifts subject to a limitations imposed by the Internal funds to invest in for-profit businesses, 40% gift tax.3 Revenue Code. This makes it unlikely and they may make grants to private that the Zuckerbergs will receive the individuals without incurring gift tax. Also, while much has been made full benefit of the deduction. of the ability of the Zuckerbergs to The bottom line is that by not avoid the capital gains tax on the In the case of contributions to public making tax-deductible contributions appreciated, publicly traded Facebook charities, and not the Zuckerbergs’ immediately and instead contributing stock contributed to charities, this presumed private foundation, the the stock to the LLC, the Zuckerbergs benefit would not apply when the aggregate deductible contributions may be foregoing the immediate tax LLC needs to sell the shares in order (including those subject to the benefit they would have received from to generate the cash necessary to separate 20% or 30% limitations contributing directly to one or more make gifts to individuals, to invest discussed below) cannot exceed 50% public charities or their own private in for-profit businesses, and to pay of adjusted gross income (AGI).4 As foundation. Furthermore, much of the governmental policy liaisons (i.e., mentioned above, excess contribu- criticism leveled at the Zuckerbergs for lobbyists). The same taxation would tions may then be carried over to the using an LLC could still be perpetuated apply to the Zuckerbergs even if succeeding five tax years and are used even if the Facebook stock were the LLC made gifts, purchased on a first-in, first-out basis. There are initially contributed directly to these investments, or made payment for also two 30% limitations that may charities because there are either no services by merely exchanging the apply in any tax year: or minimal requirements for charities Facebook stock for them rather than to immediately deploy the contribu- by selling the stock and then trans- • The first limitation applies to tions they receive for their charitable ferring the cash. These capital gains donations of cash or other property purposes. Also, charities may make taxes would obviously not be incurred other than capital gain property grants to individuals, invest in for-profit if these expenditures were instead to certain private foundations and businessses, donate to foreign charities, paid by the charities themselves certain other charities like veterans and engage in various forms of lobbying. after they received and then sold the organizations and fraternal Facebook stock to generate cash. societies.5 With regard to lobbying, Section • The second 30% limitation applies 501(c)(3) provides two options under Thus, in many ways, the Zuckerbergs to gifts of capital gain property which charities may lobby: are in a worse tax position than they (like the Facebook stock) to public would have been had they simply charities.6 1. The “no substantial part” rule, donated some of their Facebook stock which allows for lobbying, to a combination of public charities The charitable contribution amount provided the lobbying is not a and their private foundation. The for capital gain property is measured substantial part of a nonprofit’s Zuckerbergs could have perhaps also by its fair market value on the date of overall activities. received a current tax deduction the contribution; however, taxpayers and avoided the greater restrictions willing to limit their deduction to the 2. Specific definitions of lobbying imposed on private foundations by tax basis of the property can elect to and “safe harbor” spending partially using a donor-advised fund, use the 50% limitation rather than ceilings for how much charities which is treated as a public charity yet the 30% limitation for capital gain may spend on lobbying. gives the donor many of the attributes property contributed to a public of a private foundation. charity.7 Finally, the 20% limitation

pillsburylaw.com Tax applies to gifts of capital gain property of Facebook shares does not appear among charities, including those to private foundations.8 This 20% to be even a slight motivation for between public charities and private limit is applied after considering the the Zuckerbergs to form CZI or for foundations, but these distinctions 50% and 30% limits for the year. making the public pledge they did. go to the amount of the deduction a Certainly the limitations described donor is permitted and the kind of Thus, based on the limitations above, among others, illustrate that the governmental oversight to which the described above, if the Zuckerbergs alleged benefits to the Zuckerbergs organization will be subject. were to donate all or some of their of receiving a full fair market value Facebook stock to public charities, deduction for their Facebook shares is The use of an LLC for CZI will, of the deduction would be the lesser of merely theoretical. But even without course, permit secrecy not afforded to either: these deduction limitations, it would charitable organizations. Charitable be highly unlikely that the Zuckerbergs organizations are required by law to 1. 30% of their AGI. could generate enough future income make their tax returns available to the from 1% of their assets to be able to public, and CZI will not be required 2. 50% of their AGI less all other fully use the deduction created by the to do this. However, charities that contributions they made to public donation of 99% of their assets. do receive contributions from CZI charities during the year. will have to make their tax returns True, the Zuckerbergs will avoid available for public inspection. Given If the Zuckerbergs instead were the capital gains tax on the built-in the for-profit investments that may to contribute some or all of their gain inherent in their shares, but be made as part of CZI’s presumed Facebook stock to their private this has nothing to do with the business plan and the tax reporting foundation, the deduction would be structure they chose for CZI. This that will end up being reflected on the lowest of: treatment is available to all taxpayers. the Zuckerbergs’ personal income tax The Zuckerbergs could, of course, returns, the desire for confidentiality 1. 20% of their AGI. voluntarily sell their Facebook shares here is abundantly reasonable. and recognize the full capital gain and 2. 30% of their AGI less contribu- also refuse to take the tax deduction As to the criticism that the LLC will tions subject to the 30% limit. for the charitable contributions be able to engage in transactions and they make with the cash proceeds of activities that are not considered 3. 30% of their AGI less contribu- the sale. They would then pay their bona fide charitable transactions tions of capital gain property to increased tax out of the proceeds and activities like gifts to individuals, public charities. of the sale—leaving more for the investments in innovative for-profit Government and less for the causes businesses, contributions to foreign 4. 50% of their AGI less the total of CZI and the Zuckerbergs wish to charities, and lobbying for legislation contributions to public charities pursue. But why should they do this? that advances human potential and contributions subject to the This treatment is not the law; if it and promotes equality, all of these 30% limit. were, it would be bad public policy. activities can presently be conducted in some form through traditional Because the Zuckerbergs’ AGI may The IRC does not make a judgment charitable organizations. So to the be low relative to the amount of the as to which qualified organizations extent that the LLC form is criticized charitable contribution deduction in are better suited to give to than for being able to engage in these trans- any year and because the carryover is others. The statutory scheme does not actions or activities, such criticism limited to five years, the Zuckerbergs require that a donor give his or her is misguided. may never be able to fully receive the money directly to the Government benefit of the deduction. and then let it decide how the money Finally, the argument that the will be allocated. If this were the rule Zuckerbergs will not be subject to Conclusion then the wealthy would contribute tax at all on the appreciation in their The availability or lack of availability of far less to charity than they do. The Facebook stock is equally baseless. A the tax deduction for the contribution IRC does make a few distinctions fundamental principle of tax law is

Pillsbury Winthrop Shaw Pittman LLP Tax The Chan Zuckerberg Initiative: LLC for Philanthropy that one does not pay tax until the gain is both recognized and realized for tax purposes. If these events have not occurred, the Zuckerbergs could not legally be subject to taxation. While it is true that the direct donation of Facebook stock by CZI to charities (but, as discussed above, not if it is used as currency for other purchases or expenditures) will not subject the built-in gain to income tax, to the extent that CZI does not donate all of its assets to charity prior to the last of the Zuckerbergs to die, any remaining value of these assets will be included in the estate of the last to die, thus subjecting these assets to state and federal estate taxes. And, as discussed above, gifts to individuals though CZI during the Zuckerbergs’ lifetime will be subject to the gift tax; this would not be the case if the gift was instead paid by a charity and treated as a grant.

Endnotes 1 Section 170(d)(1)(A).

2 Section 4942.

3 Section 2502.

4 Section 170(b)(1)(A).

5 Section 170(b)(1)(B).

6 Section 170(b)(1)(C)(i).

7 Section 170(b)(1)(C)(iii).

8 Section 170(b)(1)(D).

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