What Are Excess Business Holdings for Private Foundations?

Excess business holdings for private foundations are ownership stakes in a for-profit business that push a foundation above the limits set by Section 4943 of the Internal Revenue Code. The core rule caps combined ownership by the foundation and its disqualified persons at 20% of a single business enterprise.¹ Anything above that limit is subject to a 10% annual excise tax on the value of the excess, and if the foundation fails to reduce its holdings before the IRS acts, a second tax of 200% applies. Neither tax is deductible.²

The 20% Combined Ownership Cap

Section 4943 doesn’t look at the foundation in isolation. It adds the foundation’s stake to everything held by its disqualified persons, and the combined number is what has to stay at or below 20%. For corporate stock, the measure is voting power. For partnerships, it’s profits interest. For trusts and other unincorporated ventures, it’s beneficial interest.³

Disqualified person holdings count first. Whatever percentage remains under the 20% cap is what the foundation itself is allowed to own. If disqualified persons hold 12% of a company’s voting stock, the foundation has 8% of room. If the foundation instead holds 15% in that scenario, 7% is excess and taxable.

The disqualified person category is broad. It includes substantial contributors (generally anyone who has given the foundation more than $5,000, where that amount is also more than 2% of total contributions received),⁴ foundation managers, 20%-plus owners of a substantial contributor entity, certain family members (spouse, ancestors, children, grandchildren, great-grandchildren, and spouses of those descendants; siblings are not included), and entities more than 35% controlled by other disqualified persons.⁵ For Section 4943 purposes, related private foundations funded or controlled by the same people also count.

When the Cap Rises to 35%

The 20% ceiling moves up to 35% if the foundation can prove to the IRS that people outside the disqualified person group have effective control of the business, meaning the actual power to direct management and set company policy.⁶ The foundation carries the burden of showing outsiders truly run the business; a minority shareholding by disqualified persons is not enough on its own.

The 2% De Minimis Safe Harbor

A foundation is not treated as having any excess business holdings in a corporation where it (with certain related private foundations) owns 2% or less of the voting stock and 2% or less of the total value of all outstanding shares.⁷ Disqualified person holdings do not affect this safe harbor. A small stake in a publicly traded company does not require insider tracking.

What Counts as a Business Enterprise

The rules apply to any trade or business carried on for profit, in any legal form: corporation, partnership, LLC, or sole proprietorship. The test is whether the activity earns income from selling goods or performing services rather than from passive investment.

Two categories are excluded entirely and therefore fall outside the ownership limits:⁸

A largely passive business, defined as one earning at least 95% of its gross income from dividends, interest, rents, royalties, and similar passive sources. A pure holding company generally qualifies.
A functionally related business that directly carries out the foundation’s charitable purpose, such as a vocational workshop operated by a job-training foundation.⁹

Real estate can go either way. A foundation collecting rent passively is fine; one that develops property, negotiates leases, and manages tenants is running a business enterprise subject to the ownership limits.

Non-Voting Stock and Indirect Ownership

Non-voting stock is treated differently depending on what disqualified persons hold. If disqualified persons own 20% or less of the voting stock, the foundation can hold non-voting stock without restriction. Once disqualified persons cross 20% on the voting side, any non-voting stock the foundation holds becomes excess as well.¹ The mechanic exists to block a workaround where insiders keep voting control and the foundation parks capital in non-voting shares.

Indirect ownership also counts. When a foundation holds an interest in a partnership or trust that owns stock in a business enterprise, the foundation is deemed to own a proportionate share of that underlying business, and the same attribution applies to disqualified persons.¹⁰ Complex investment structures have to be traced through every layer to arrive at the real percentage.

The 10% and 200% Excise Taxes

The penalty system is designed to make excess holdings expensive fast.

The initial tax is 10% of the value of the excess for each tax year that ends during the taxable period, measured on the day during the year when the excess was largest. Selling down partway through the year does not erase the tax if the excess existed at any peak point. The taxable period begins the first day the excess exists and ends when the IRS mails a notice of deficiency or formally assesses the tax, whichever comes first.¹¹ The 10% applies for every tax year within that window.

If the foundation still holds excess business interests at the close of the taxable period, the IRS imposes a second tax of 200% of the remaining excess.¹² Between the annual 10% and the threat of a 200% follow-up, sitting on the excess becomes more costly than selling at a loss.

Both taxes fall on the foundation itself. Section 4943 does not impose a separate penalty on individual foundation managers, unlike the self-dealing rules under Section 4941.

Grace Period for Gifts and Bequests

Foundations often end up with excess holdings through no decision of their own, when a donor gives or leaves them a concentrated position in a business. The tax code gives them five years to sell off the excess without penalty.¹³ During those five years, the newly acquired interest is treated as if it were held by a disqualified person rather than by the foundation, so it does not trigger the excise tax.

The grace period applies only to interests received by gift, bequest, or similar non-purchase means. A voluntary purchase that creates excess holdings gets no grace period at all. The clock runs from the date of acquisition, not the date the foundation notices the problem, so planning should start immediately, even while an estate is still in probate.

An additional five years, for ten total, is available when holdings are unusually large, diverse, or structurally complex. To qualify, the foundation has to show it made diligent efforts to sell during the initial period and could not do so at a fair price, submit a written disposition plan to the IRS, share the plan with the state attorney general or equivalent official (forwarding any response to the IRS), and receive an IRS determination that the plan can reasonably be carried out.¹⁴ Extensions typically involve closely held businesses without a ready market of buyers, where a large block cannot be moved quickly without destroying value.

Getting the First-Tier Tax Abated

Section 4962 gives the IRS discretion to abate the 10% tax if the foundation shows the violation was due to reasonable cause and not willful neglect, and that the excess was corrected within the required time frame.¹⁵

The standard is ordinary business care and prudence, and it’s stricter than many foundations expect. Not knowing the rules doesn’t count. Verbal advice from a tax advisor doesn’t count either. What the IRS and courts look for is a reasoned written legal opinion that specifically addresses the issue.¹⁵ A foundation that receives a large stock bequest, consults counsel promptly, obtains that written opinion, and starts pursuing buyers has a credible abatement case. A foundation that ignores the problem for years does not. Note also that abatement is available only for the first-tier 10% tax, not the 200% additional tax.

The 100% Philanthropic Business Exception

Section 4943(g), added by the Tax Cuts and Jobs Act of 2017, allows a foundation to own 100% of a business if the arrangement genuinely channels all profits to charity with no insider involvement. It is sometimes called the Newman’s Own exception after the company and foundation whose structure prompted it.¹⁶

Every one of the following conditions has to be met in every tax year:

The foundation holds 100% of the voting stock at all times during the year.
Every ownership interest was acquired by gift, bequest, or other non-purchase means.
The business distributes an amount equal to its net operating income to the foundation within 120 days after the close of its tax year. Net operating income is gross income minus directly connected deductions, income taxes owed by the business, and a reasonable working-capital reserve.
No substantial contributor to the foundation, and no family member of one, serves as a director, officer, manager, employee, or contractor of the business.
A majority of the foundation’s board consists of people who are not directors or officers of the business and are not family members of substantial contributors.
The business has no outstanding loans to substantial contributors or their family members.

The conditions are strict because the exception effectively lets a foundation run a commercial enterprise tax-free. Losing eligibility in a single year brings the standard excess business holdings rules back for that year, along with a possible 10% tax.

Reporting and Ongoing Compliance

Private foundations report their business holdings annually on Form 990-PF. A foundation that owes the 10% or 200% tax also files Form 4720 to calculate and pay it.¹⁷ The filing obligation is the same whether the excess came from a purchase or an unexpected bequest.

Compliance is not a one-time check. A foundation that is clean today can be in violation tomorrow if a disqualified person buys more stock, if a family member inherits shares, or if the business issues new stock that shifts ownership percentages. Foundations holding anywhere near the 20% or 35% ceilings should monitor ownership changes among all disqualified persons at least quarterly and document what they find.

1
Office of the Law Revision Counsel. 26 USC 4943 – Taxes on Excess Business Holdings
2
Office of the Law Revision Counsel. 26 USC 275 – Certain Taxes
3
Internal Revenue Service. Taxes on Excess Business Holdings
4
eCFR. 26 CFR 1.507-6 – Substantial Contributor Defined
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Office of the Law Revision Counsel. 26 USC 4946 – Definitions and Special Rules
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Office of the Law Revision Counsel. 26 USC 4943 – Taxes on Excess Business Holdings – Section: 35 Percent Rule
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Internal Revenue Service. IRC Section 4943 – Taxes on Excess Business Holdings
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Office of the Law Revision Counsel. 26 USC 4943 – Taxes on Excess Business Holdings – Section: Definitions, Special Rules
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Office of the Law Revision Counsel. 26 USC 4942 – Taxes on Failure to Distribute Income – Section: Functionally Related Business
10
Internal Revenue Service. Attribution of Ownership Rules – Definition of Disqualified Persons
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Office of the Law Revision Counsel. 26 USC 4943 – Taxes on Excess Business Holdings – Section: Taxable Period
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Office of the Law Revision Counsel. 26 USC 4943 – Taxes on Excess Business Holdings – Section: Additional Tax
13
eCFR. 26 CFR 53.4943-6 – Five-Year Period to Dispose of Gifts, Bequests, Etc.
14
Office of the Law Revision Counsel. 26 USC 4943 – Taxes on Excess Business Holdings – Section: 5-Year Extension
15
Internal Revenue Service. Abatement of Chapter 42 First Tier Taxes Due to Reasonable Cause
16
Office of the Law Revision Counsel. 26 USC 4943 – Taxes on Excess Business Holdings – Section: Exception for Certain Holdings Limited to Independently-Operated Philanthropic Business
17
Internal Revenue Service. Private Foundation Excise Tax Return (Form 4720)