IRS ruling shields stock buyout from foundation self-dealing tax

The Internal Revenue Service has approved a post-death stock buyout for a group of related shareholders, ruling that a company's option to repurchase their stock will not trigger the private-foundation self-dealing tax. The approval, Private Letter Ruling 115158-25, is conditional: the buyout must satisfy every element of the estate administration exception. WealthManagement.com covered the ruling in its September tax update.

The tax at issue is Section 4941 of the Internal Revenue Code, an excise tax on self-dealing between a private foundation and its disqualified persons — the founders, their families, and the entities they control. For a closely held business owner who also runs a foundation, that statute turns a routine post-death stock purchase into a potential penalty event. This ruling says the configuration before the IRS passes.

The facts: several related taxpayers owned a majority of a closely held company. Each maintained a revocable trust directing the trustees, after the deaths of the taxpayer and spouse, to set aside a fixed portion of the trust property for charitable organizations the trustees select. A private foundation could be among the recipients, but the trust did not require it. The trustees had six months from the death to make the charitable designation irrevocable. The company separately held an option to buy stock from each trust at fair market value within 15 months of the death.

The IRS first confirmed that the taxpayers and the company are disqualified persons with respect to the foundation. Then it drew the line: the foundation had no interest or expectancy in the company's stock merely because it could someday receive it. That interest arrives only when the trustees actually decide to benefit the foundation. Once they do, transactions involving that property sit inside Section 4941 — unless an exception applies.

The applicable exception is the estate administration exception, Treasury Regulation Section 53.4941(d)-1(b)(3). It removes indirect self-dealing from the tax when a transaction involves property in which a foundation has an interest or expectancy, held by an estate or revocable trust, and five conditions are met. The executor or trustee must have the power to sell the property, a court must approve the transaction, the deal must occur before the estate is terminated for federal income tax purposes, the trust must receive at least fair market value, and the foundation must receive an interest or expectancy at least as liquid as the one it gave up. The IRS determined the exception fits this plan.

Two timers start at death. The trustees have six months to make the charitable beneficiaries irrevocable. The company has 15 months to exercise its option. For the first stretch, before the designation is made, the foundation is only a possible recipient — no prohibited interest, no Section 4941 issue. The problem begins at the designation. From that point until the estate closes, every move involving the stock needs an exception attached.

The planning lesson is mostly drafting. The condition most likely to be undersold is court approval. A company buying stock from a decedent's trust is normally a private matter between trustee and board; the estate administration exception makes it court-supervised, and the transaction must conclude before the estate terminates for federal income tax purposes. That is a calendared step, not a signature at closing. Advisors who write the exception's conditions into the trust and the option agreement — the power to sell, the fair-market price, the court approval, the liquidity match — have this ruling built into the deal. Advisors who do not are betting that the two deadlines will line up without anyone scheduling them.

The liquidity condition has its own wrinkle. The foundation must emerge from the transaction with an interest at least as liquid as the one it surrendered. A cash buyout clears that test easily; cash is more liquid than the stock the foundation might have received. The ruling does not address the harder version — one illiquid interest swapped for another — and says nothing about how the IRS would treat that trade. A future ruling will likely test the exception on just those facts. This one answers only the clean case: cash, a court date, and a transaction finished while the estate is still open for tax purposes.