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, Mark Zuckerberg 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 Facebook 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.