Mark Zuckerberg and Pricilla Chan’s recent announcement of their $45,000,000,000 planned gift to the Chan Zuckerberg Initiative, LLC has generated lots of press, much confusion, and interesting questions from our own clients.
The groundbreaking Facebook founder has once again broken with tradition and formed his philanthropy as an LLC. Clients have questioned the benefits of choosing to forgoe the traditional private foundation in favor of an LLC. We are here to break it down.
Treatment of LLC
An LLC is by default a pass-through entity for tax purposes. This means that unless a special election is made, all the financial activity passes through the LLC to the owners. Therefore, when the LLC makes money, its members will recognize the gain and pay tax on it. When the LLC loses money, the loss will flow through to the members. When it makes a charitable donation, its members will receive the benefit of the charitable tax deduction. Accordingly, when stock is transferred to the LLC, Mr. Zuckerberg and Ms. Chan have simply moved an asset from one pocket to the other and they receive no tax benefits.
Advantages over Traditional Private Foundation
Although the Chan Zuckerberg Initiative, LLC appears to be a traditional business entity, due to their announcement to use it as a vehicle to conduct charitable and social activities, we are going to refer to it as a “Philanthropic LLC.” From the donors’ point of view, there are a number of advantages to the Philanthropic LLC.
No Minimum Distributions. Unlike a traditional private foundation, LLCs do not have to distribute a set amount each year. Thus, the timing and amount of grants from the Philanthropic LLC will be purely discretionary.
No Taxable Expenditures. Another difference is that donations can be made to individuals, to non-charities, or to support projects abroad without obtaining IRS pre-approval or following the additional recordkeeping requirements applicable to private foundations that make such gifts.
No Self-Dealing Restrictions. The founders are free to transact with the LLC without worrying about violating the rules against self-dealing that apply to private foundations.
No Excess Business Holding Limits. Further, a private foundation cannot own more than 20% of any one company’s stock. The Zuckerberg Chan Initiative faces no such limitation.
No Lobbying and Electioneering Prohibitions. Additional benefits include the ability to engage in lobbying. Private foundations are prohibited from lobbying; however, LLCs are free to lobby as they see fit. Charitable foundations can’t make political donations; LLCs can.
No Transparency. The tax filings for the Zuckerberg Chan Initiative will not have to be made public. Therefore, it will not have to disclose compensation for its top five executives and independent contractors, something that private foundations are required to do in their publicly available annual 990-PF tax filings.
Disadvantages as compared to a Traditional Private Foundation
Income is Taxable at Individual’s Tax Rate. The income earned by the Philanthropic LLC is taxable and flows through the LLC to the member’s tax return where it is taxed at the individual’s tax rate. In contrast, once funds are contributed to a private foundation, the foundation pays only 1% to 2% on the investment income.
Tax Deductions are Deferred. Philanthropic LLCs offer no tax advantages. The tax consequences to the owner of the LLC are the same whether the owner writes a personal check to charity or transfers funds to their LLC and has the LLC write the check. Thus, unlike a gift to a private foundation which is deductible when funds are transferred to the foundation, a gift to a philanthropic LLC is deductible only when the LLC makes a gift to charity.
Reversion Clause Can Destroy Tax Deduction. One benefit of a private foundation is the ability to make grant agreements enforceable by stating that if the terms are breached the remaining funds will revert to the foundation. This ensures the foundation retains something at stake and creates a basis to argue that the foundation has standing to enforce the terms of the gift in court. If the donor does not include any reversion many courts would consider them not to have a sufficient stake in the matter to support a claim. Individual donors are at a disadvantage when making complex grants because if there is more than a remote possibility that funds will revert to an individual donor then the gift is arguably incomplete for tax purposes and is not deductible. Similarly, Philanthropic LLCs risk losing their charitable tax deductions if they include reversion clauses in their grant agreements to ensure enforceability.
Funds Expended on Administration may not be Deductible. When an individual donates funds to a private foundation, those funds are fully deductible even if a significant portion goes to pay staff or otherwise support the management of the foundation. In contrast, only the funds that are ultimately granted to charity will generate tax deductions for the LLC’s members.
From a tax perspective, Zuckerberg could achieve the same result by simply writing checks to charities. By wrapping an LLC around his philanthropy, he is able to segregate his social endeavors from his business and personal finances. Further, his philanthropy is on such a large scale that he will need to hire staff, locate office space, and incur expenses that one does not typically want to run through a personal checking account. One article speculated that Mr. Zuckerberg and Ms. Chan have far more charitable deductions than they can use anyway making tax benefits less of a concern for them. Ultimately, the Chan Zuckerberg Initiative, LLC is designed to give its founders maximum flexibility and control while sacrificing some of the valuable tax benefits associated with private foundations, something most philanthropists are not in a position to do.
Ellis Carter is a nonprofit lawyer licensed to practice in Washington and Arizona. Ellis advises tax-exempt clients on federal tax matters nationwide. If you are seeking legal advice, contact firstname.lastname@example.org or 602-456-0071 for information about our services.