Is Mark Zuckerburg's Limited Liability Company the New Model for Charitable Giving?

Is Mark Zuckerburg's Limited Liability Company the New Model for Charitable Giving?

Article posted in Foundations on 16 March 2016| 3 comments
audience: National Publication, Richard L. Fox, Esq. | last updated: 16 March 2016
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Summary

Much has been written about the gift made by Mark Zuckerberg and his wife, Dr Priscilla Chan. A lot of it has been critical. Author Richard Fox contributes a revealing article that thoroughly analyzes much of the reasoning behind this structure.

As has been widely publicized, Mark Zuckerberg, Chairman and CEO of Facebook, recently announced that he is contributing during his lifetime 99 percent of his shares in Facebook, valued at approximately $45 billion.  Instead of donating the shares to a private foundation, the model traditionally used by philanthropists, including Bill Gates who transferred shares of Microsoft to the Bill and Melinda Gates Foundation (“Gates Foundation”), the largest private foundation in the country, Zuckerberg is transferring his Facebook shares to a newly formed Delaware limited liability company (“LLC”) known as the Chan Zuckerberg Initiative (hereinafter the “Zuckerberg LLC”), formed by Zuckerberg and his wife, Dr. Priscilla Chan, as a vehicle for advancing “philanthropic, public advocacy and other activities for the public good.” 

In a December 1, 2015 letter to their newborn daughter, Max, in which the charitable commitment was first announced, Chan and Zuckerberg stated the following:

As you begin the next generation of the Chan Zuckerberg family, we also begin the Chan Zuckerberg Initiative to join people across the world to advance human potential and promote equality for all children in the next generation. Our initial areas of focus will be personalized learning, curing disease, connecting people and building strong communities.  We will give 99% of our Facebook shares -- currently about $45 billion -- during our lives to advance this mission. We know this is a small contribution compared to all the resources and talents of those already working on these issues. But we want to do what we can, working alongside many others.

Although an LLC can qualify as a Section 501(c)(3) tax-exempt entity,[1] in which case it would be classified as a private foundation where there are only one or a few donors,[2] the newly created Zuckerberg LLC is not going to be classified as a Section 501(c)(3) tax-exempt entity and, therefore, will not be a private foundation.  Unless it elects to be treated as a corporation, which is certainly not going to be the case, it will be treated as a pass-through entity for tax purposes.[3]   Therefore, although it is formed to further philanthropic purposes, the Zuckerberg LLC but will be treated for tax purposes like any other LLC, where all of its tax attributes flow through to its member or members.   It will also avoid the highly restrictive federal tax regime first imposed upon private foundations by Congress under the Tax Reform Act of 1969 including, but not limited to, an annual distribution requirement generally mandating that a private foundation distribute 5 percent of the fair market value of its assets for charitable purposes each and every year. 

Assuming $45 billion of assets, the Zuckerberg LLC will not have to meet the private foundation five percent distribution requirement of $2.25 billion each year and, in fact, is actually not required to make any charitable distributions.  In contrast, the Gates Foundation, having assets exceeding $40 billion and which is subject to the private foundation five percent annual distribution requirement, reported on its 2013 Form 990-PF that it made grants for charitable purposes during 2013 in excess of $3.3 billion. 

Because it is not a private foundation, contributions to the Zuckerberg LLC are not deductible for charitable income tax purposes, although such a deduction is only meaningful to the extent that the donor has significant income.  This is the case because in any given year, a charitable income tax deduction for a contribution of appreciated securities to a private foundation is limited to 20 percent of the donor’s adjusted gross income.  Despite his great wealth from his holdings of Facebook shares, which do not pay dividends, Zuckerberg's  income may actually be relatively modest, as his official salary last year was $1.  Because of the 20 percent  annual adjusted gross income cap (with a maximum five-year carryover period), Zuckerberg could never use the full tax deduction he would otherwise be entitled to even if contributions of the $45 billion of Facebook stock to the Zuckerberg LLC were tax deductible.

Because the Zuckerberg LLC is not exempt from income tax, any of its taxable income flows through to its member or members, who report such income on their own income tax returns. But, with Facebook currently not paying dividends, the Zuckerberg LLC may generate little, if any, taxable income, making the absence of a tax exemption under Section 501(c)(3) of little value. And, if its wants to make contributions to charity to further its mission, the Zuckerberg LLC could actually make gifts of appreciated Facebook stock, which produces a charitable income tax deduction at fair market value and, as the same time, does not trigger any capital gain recognition upon the contribution.  Not triggering capital gain tax upon a contribution of appreciated securities to charity should be contrasted from the situation where the securities are first sold, and then the cash proceeds are contributed to charity, where capital gain is recognized in this situation.

What Benefits Does the LLC Model Have Over the Private Foundation Model?

The benefits of the LLC model over the private foundation model is that the LLC avoids the multitude of restrictions and requirements  applicable to private foundations, both at the federal and state level, thereby making the LLC a much more flexible vehicle that can engage in a wide variety of activities and make investments and expenditures that would be prohibited if it were a private foundation.  Therefore, in choosing an LLC,  Zuckerberg and Chan have more leeway in the types of causes they want to support and the investments they want to make, and obtain anonymity that is not available with a private foundation. At the same time, like a donor who establishes a private foundation, they retain control over the operations of the LLC and can make decisions regarding its investments, contributions, expenditures, and all of its other activities.  

Unlike in the case of a private foundation, the assets contributed to an LLC are not permanently restricted for charitable purposes, but can be used for any permissible purposes under state law.  Typically, an LLC can be dissolved and liquidated, with the assets then held by the LLC distributed back to its member or members.  Therefore, unlike a private foundation, the assets of an LLC are not subject to State Attorney General oversight, who has authority over the administration of assets dedicated to charitable purposes. Moreover, an LLC avoids the multitude of private foundation restrictions and limitations contained in the Internal Revenue Code, its substantial penalty regime for lack of compliance, and the IRS that comes with any organization being classified as a private foundation.   As a result not being subject to the private foundation rules, an LLC is not subject to the following requirements applicable to a private foundation and its penalty regime for lack of compliance:

  1. The requirement to file an annual Form 990-PF, Return of Private Foundation, with the IRS (and the State Attorney General).   This form, which discloses virtually all information about a private foundation, is open for public inspection and most include the names of the donors and the amounts contributed, as well as its investments, expenditures and a host of other information about the entity, all publicly available.
  1. The five percent annual distribution requirement under Section 4942.
  1. The “excess business holdings rule” of Section 4943, which limits the amount of stock and other interests in business enterprise  that can be held, and would not permit the Zuckerberg LLC to hold all of the stock in Facebook that is being contributed to it.
  1. The “jeopardy investment rule” of Section 4944, which limits the type of investments that can be made, particularly speculative investments in start-up companies.
  1. The “self-dealing rules” of Section 4941, which would limit transactions from taking place with the founders.
  1. The “taxable expenditure rules” of Section 4945, which prohibits various expenditure from being made, including those for political and lobbying purposes. 

What Benefits Does the Private Foundation Model Have Over the LLC Model?

The benefits of the private foundation model over the LLC model are tax advantages.  Charitable contributions to the foundation are deductible for income tax purposes in the year of the contribution,  although actual distributions from the foundation to other charitable organizations may be deferred over a period of time well beyond the year in which the contribution is first made to the foundation.  The income earned on the assets of the foundation is exempt from federal income tax and, therefore, can be invested and grow on a tax-free basis.[4]   A private foundation is often created upon a donor realizing a significant amount of income in a particular year, with the donation to the foundation substantially reducing the tax on such income.

Should the Zuckerberg LLC Model Be Criticized or Praised?

Interestingly, the Zuckerberg LLC model has been the subject of criticism.  In “How Mark Zuckerberg’s Altruism Helps Himself,” by Jesse Eisinger, Pro Publica (December 3, 2015), for example, the author is highly critical of the Zuckerberg LLC model and questions its charitable intent, and starts with the following passage: “Mark Zuckerberg did not donate $45 billion to charity. You may have heard that, but that was wrong.  Here’s what happened instead: Mr. Zuckerberg created an investment vehicle. Sorry for the slightly less sexy headline.”  And, specifically with respect to the transfer of the $45 billion of Facebook stock to the Zuckerberg LLC, the article states:

In doing so, Mr. Zuckerberg and Dr. Chan did not set up a charitable foundation, which has nonprofit status. He created a limited liability company, one that has already reaped enormous benefits as public relations coup for himself. His P.R. return-on-investment dwarfs that of his Facebook stock. Mr. Zuckerberg was depicted in breathless, glowing terms for having, in essence, moved money from one pocket to the other.

An L.L.C. can invest in for-profit companies (perhaps these will be characterized as societally responsible companies, but lots of companies claim the mantle of societal responsibility). An L.L.C. can make political donations. It can lobby for changes in the law. He remains completely free to do as he wishes with his money. That’s what America is all about.  But as a society, we don’t generally call these types of activities “charity.”  (Emphasis added.)

In response to criticism of the of the LLC model, an article in Forbes, “Mark Zuckerberg And His Charitable Plan Should Be Followed, Not Criticized,” Danielle and Andy Mayoras (December 9, 2015), defended the Zuckerberg LLC model.  The article notes that the LLC model is perfectly legal, there are a wide variety of vehicles that can be used to further philanthropy, and that the LLC model is just one of many and that “Mark Zuckerberg and Priscilla Chan deserve applause, not scorn” for creating and funding the Zuckerberg LLC. Mr. Zuckerberg himself has explained his choice of use of the LLC model, in lieu of the traditional private foundation vehicle, as follow:

The Chan Zuckerberg Initiative is structured as an LLC rather than a traditional foundation. This enables us to pursue our mission by funding non-profit organizations, making private investments and participating in policy debates -- in each case with the goal of generating a positive impact in areas of great need. Any net profits from investments will also be used to advance this mission. By using an LLC instead of a traditional foundation, we receive no tax benefit from transferring our shares to the Chan Zuckerberg Initiative, but we gain flexibility to execute our mission more effectively. In fact, if we transferred our shares to a traditional foundation, then we would have received an immediate tax benefit, but by using an LLC we do not. And just like everyone else, we will pay capital gains taxes when our shares are sold by the LLC.

While Mr. Zuckerberg notes above that if he has used the traditional private foundation model, he would have received an immediate tax benefit, this presupposes that that he would have sufficient income to utilize any available deduction. As indicated above, since charitable deductions for contributions of appreciated securities to a private foundation are capped each year at 20 percent of adjusted gross income (with a maximum five-year carryover period), Zuckerberg could never use the full tax deduction he would otherwise be entitled to if the contribution of $45 billion of Facebook stock to the Zuckerberg LLC was tax deductible.  In addition, while it is true that any capital gain realized upon a sale of Facebook stock by the LLC would be subject to capital gain tax, this tax can be avoided if Facebook stock is actually used as the currency to make charitable contributions, where the fair market value of the stock can be deducted without triggering any capital gain.

Interestingly, the use of LLCs as a vehicle to advance philanthropic goals is not new.   LLCs have previously been used to engage in philanthropic ventures, including the Emerson Collective, an LLC created by Laurene Powell Jobs, the widow of the late Steve Jobs, and the LLC formed as a part of the Omidyar Network by eBay founder Pierre Omidyar and his wife, Pam Omidyar. 

In a May 24, 2013 article in the New York Times, “Laurene Powell Jobs and Anonymous Giving in Silicon Valley,” Claire Cain Miller reported that one of the main ways Ms. Powell Jobs keeps her donations anonymous is by cleverly making her organization, Emerson Collective, a limited liability company, and notes the increasing popularity of LLCs being used as philanthropic vehicles.  The article states:

[The LLC] strategy is becoming more common, as people seek flexibility, freedom and anonymity in their investments, said Laura Arrillaga-Andreessen, who teaches philanthropy at Stanford, runs her own philanthropy and is a close friend of Ms. Powell Jobs.  “The beauty of having an LLC in today’s world is No. 1, you have the ability to act and react as nimbly as need be to create change, and you have the ability to invest politically, in the for-profit sector and the nonprofit sector simultaneously,” she said.  “And the reality is,” she added, “we are now seeing a blurring of the lines between the sectors in a way that was not even discussed 10 years ago. The way that we are going to solve social problems is by working with multiple different types of investing.”  Ms. Powell Jobs said that Emerson did not need the tax structure of a foundation, and that “doing things anonymously and being nimble and flexible and responsive are all things we value on our team.”

As noted in a December 23, 2015 article by Stephen Foley in the Financial Times, “How to give away $1bn,” the world's 1,826 billionaires, many of them relatively newly minted moguls reared in the world of Silicon Valley, are exploring new avenues to pursue social agendas, challenging traditional foundation and donation models in ways that could redefine philanthropy, and stating that “they are engaging in philanthropic endeavor at an intriguing time, as old ways of giving are being challenged and even the definition of what it means to be a philanthropist appears to be expanding.” The article examines emerging ways that today's mega-donors are crafting their philanthropy, including the hybrid structures adopted by eBay founder Pierre Omidyar and Mark Zuckerberg, who, the article notes, set up limited-liability companies that make impact investments as well as grants to nonprofits.  The article quotes Pierre Omidyar from 2003 as saying it was “no-brainer” when he decided to reject the traditional model of U.S. philanthropy and not use a charitable foundation for his giving.  According to the article, there would be an extra tax bill of $1 million or $2 million a year for doing so, but in the context of spending $100 million annually on philanthropic works, Omidyar considered that a small price to pay for what, years later, he called ‘the flexibility to use every possible tool to improve the world’.”

Conclusion

While there is certainly still a place for the use of the traditional private foundation to carry out an individual’s philanthropy, and private foundations continue to enjoy growing popularity, the use of an LLC may be a compelling alternative, and one that should be considered when determining an appropriate philanthropic model, particularly where tax benefits are not a significant concern and where the proposed activities and expenditures are not permitted by a private foundation. Although an LLC has its advantages, unlike a private foundation, contributions to an LLC are not tax deductible and the income realized by an LLC is not exempt from income tax, two significant advantages of private foundation status.

The LLC approach apparently works for Mark Zuckerberg, who opted for an LLC in lieu of the traditional private foundation approach, as well as others who have decided to engage in philanthropy using the more flexible and less restricted LLC model. As long as it allows a donor’s philanthropic intent to be accomplished, and any reduction of taxes offered by a private foundation is not considered compelling, any criticism aimed at using an LLC as a philanthropic vehicle is not well-founded.  In addition, there is no prohibition upon a donor using both an LLC and a private foundation, in tandem, for philanthropic purposes.



[1] See Instructions to Form 1023, Application for Recognition of Exemption; IRS 2001 EO CPE Text (“Limited Liability Companies as Exempt Organizations – Update”).

[2] After an entity is determined to be a Section 501(c)(3) tax-exempt entity, a determination must then be made under Section 509(a) as to whether the entity is a “public charity” or “private foundation.”  Generally, unless  an organization having only a limited number of donors can qualify as a supporting organization under Section 509(a)(3), it will be classified as a private foundation. 

[3] If there is only one member, an LLC is treated as a “disregarded entity” and does not file a tax return.  If there are two or more members, the LLC is treated as a partnership, and files a Form 1065, U.S. Partnership Tax Return.

[4] A private foundation is subject to a net investment excise tax of either 1% or 2% under Section 4940. 

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Comments

Re: Is Mark Zuckerburg's Limited Liability Company the New ...

Shame on Zuckerburg for not funding a PF to hire his kids, not forcing thousands of dollars per year in tax compliance revenue for CPAs and attorneys, and not wanting to constantly be afraid that a foot fault in operating a PF could bring down the wrath of the federal government. Good analysis of the flexibility that we should all be building into our plans for clients rather than capitulating to the nightmarish regulatory burden imposed by Congress. Even if this LLC fund is not yet permanently set aside for charity, good people do good things eventually. Especially when they can afford to.

Re: Is Mark Zuckerburg's Limited Liability Company the New ...

While the LLC model seems to be the better fit for the donors mentioned in the article, it seems that the advantages of an LLC model over a private foundation model are relatively short lived, unless the founders are willing to pay an enormous estate tax at their deaths. If they are not, then a bequest of their membership interests to a private foundation to avoid the estate tax seems inevitable, unless I am missing something?

Re: Is Mark Zuckerburg's Limited Liability Company the New ...

Thanks for illuminating the benefits of using the LLC for philanthropic endeavors. I think it is a great tool for some. Traditional philanthropy through private foundations, donor advised funds, etc. will not go away but it is always good to see if there is a better (or different) "mouse trap" that could be utilized by those who do not wish to use the traditional tools.

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