Hedge Fund Partnership Interest Donation to a Private Foundation
A focus on investment managers
On April 23, 2013, the Internal Revenue Service (IRS) issued Private Letter Ruling (PLR) 201329028 stating that a private foundation (PF) will generally have no adverse tax consequences after receiving a donation of a certain hedge fund interest.
Generally, a private foundation organized as a tax-exempt entity is liable for income tax on certain types of net Unrelated Business Taxable Income (UBTI) under IRC Sec. 512 and other excise taxes under IRC Secs. 4943 & 4944 and the regulations there under.
As stipulated in the PLR, a gratuitous donation of hedge fund interest, where the hedge fund (HF) does not generate or earn UBTI, to a private foundation that will own more than twenty percent interest in profits, will generally not create an adverse tax consequences to the private foundation.
Summary of the PLR
In the PLR, the IRS considered a situation in which a HF organized as a limited liability company and treated as a partnership for federal income tax purposes, had three classes of membership units – Class A, B, and C. PF already a Class A member with a greater than ten percent ownership interest, was to receive via donation of the sole Class B interest from donor. The Class B member was entitled to ten percent of HF income.
HF used "funds for the sale, purchase, and trading of financial instruments traded on public financial markets, including stocks, stock indices, exchanged-traded funds, real estate investment trusts, mutual funds, bonds, currencies, and derivatives of these instruments." Generally, "passive income" such as dividends, interest, payments with respect to securities loans, annuities, capital gains and losses, and certain rents are not considered UBTI, unless the assets which generate such income were acquired or held with the use of borrowings. The private foundation represented that the assets did not constitute debt financed property.
The IRS addressed three main factors on why there were to be no adverse tax effects to PF on the donation:
- The investment activities of the HF did not give rise to and did not generate UBTI with respect to the PF's Class A investment and proposed Class B investment,
- PF's ownership of more than twenty percent of HF profits (comprising of Class A membership interest and/or proposed ownership of a Class B interest in HF) did not cause the PF to be liable for an excess business holding excise tax under IRC Sec. 4943, and
- The proposed donation of the Class B membership interest in the LLC would not result in a jeopardizing investment under IRC Sec 4944.
It is important to note that under general tax principles, private donations may be subject to income and/or excise tax if certain conditions apply. Private foundations should consult with their tax advisors should they have any of the following types of activity that may be treated as UBTI:
- Debt-financed income
- Active trade or business income or loss
- Excess business holdings
- Jeopardizing charitable purposes of assets purchased by the private foundation
Moreover, the tax deduction consequences to the donor were not addressed in the Ruling.
Although IRC Sec. 6110(k)(3) states that a PLR cannot be cited as precedent, the IRS ruled in this circumstance that the donation of a partnership interest in a HF would not cause any adverse effects to the private foundation.
Taxpayers looking to donate a partnership interest to a private foundation, or private foundations looking to receive a donation of a partnership interest, please contact the practitioners below for additional information or questions.
For additional information or questions, please contact:
National Managing Partner, Asset Management Tax
Deloitte Tax LLP
+1 212 436 2165
Deloitte Tax LLP
+1 203 708 4696
Deloitte Tax LLP
+1 202 879 5320
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