Private Foundation Excess Business Holdings: 20% Cap and Excise Taxes

The private foundation excess business holdings rules, set out in Section 4943 of the Internal Revenue Code, cap the combined ownership a foundation and its insiders can hold in an active business at 20% of voting stock, and impose a 10% excise tax on any excess that jumps to 200% if the foundation fails to correct the problem in time.¹ The rules exist to keep foundations focused on charitable work rather than serving as holding companies for family businesses.

The 20% Ceiling

The baseline is a single combined limit. The foundation plus every disqualified person (its insiders, defined below) can together hold no more than 20% of a company’s voting stock.¹ The foundation’s own slice is whatever is left after subtracting insider holdings. If disqualified persons already own 15% of a company’s voting shares, the foundation can hold up to 5%.

Voting stock means shares carrying the right to vote for directors or on corporate decisions. Non-voting stock is treated differently: a foundation can hold any amount of it, but only so long as all disqualified persons together own no more than 20% of the voting shares.² Once insiders cross that voting threshold, the foundation’s non-voting shares lose their safe harbor and get pulled into the excess holdings calculation.

The ceiling rises to 35% in one specific situation: when an unrelated third party effectively controls the business. The third party cannot be a disqualified person and must hold enough voting power to actually direct management. In practice this usually means the third party holds more voting stock than the foundation and its insiders combined.¹

The same principles apply to unincorporated businesses using adjusted terminology. Partnerships and joint ventures substitute “profits interest” for voting stock and “capital interest” for non-voting stock. Trusts use “beneficial interest.” Sole proprietorships are a special case: a foundation has no permitted holdings at all.²

What Actually Counts as a Business Enterprise

The rules only apply to an active trade or business operated to produce income. Two categories of holdings sit outside the framework entirely, and a foundation that misclassifies one may rush to sell an asset it was allowed to keep.

The first exclusion covers businesses where at least 95% of gross income comes from passive sources: dividends, interest, rents, and royalties.¹ A family investment company that simply holds a portfolio of stocks and bonds typically falls here, no matter how large the foundation’s stake.

The second exclusion covers “functionally related businesses,” meaning operations substantially related to the foundation’s charitable mission beyond just producing revenue. A museum gift shop, a hospital cafeteria serving patients and staff, and a thrift store selling donated goods are the standard examples.³ A business where substantially all work is performed without compensation also qualifies.

Who Counts as a Disqualified Person

Applying the 20% cap requires adding up every share held by the foundation’s insiders. The category is broad:

Substantial contributors: anyone who has given more than $5,000 to the foundation where that amount exceeds 2% of all contributions the foundation has ever received.⁴
Foundation managers: officers, directors, and trustees with authority to act for the organization.
Anyone owning more than 20% of a corporation, partnership, or trust that is itself a substantial contributor.⁵
Family members: spouses, ancestors, children, grandchildren, great-grandchildren, and the spouses of those descendants.⁵

Every share held by any of these people counts against the combined 20% limit. A foundation created by a single family can easily accumulate dozens of disqualified persons across generations.

Indirect Ownership

Constructive ownership rules pull in holdings held through intermediaries. A foundation is treated as owning its proportionate share of any business held through a corporation, partnership, or trust.⁵ A 50% stake in a holding company that itself owns 40% of an operating business gives the foundation constructive ownership of 20% of that operating business. The same look-through applies to disqualified persons. Accurate tracking requires current organizational charts and ownership records for every related entity.

The 2% Safe Harbor

A small stake sidesteps the rules entirely. The safe harbor applies when the foundation, together with all other foundations controlled by the same people, owns no more than 2% of the voting stock and no more than 2% of the total value of all outstanding shares across every class.¹ Both conditions have to be met. This protects foundations holding diversified investment portfolios even when disqualified persons independently own large stakes in the same companies.

The 100% Philanthropic Enterprise Exception

A foundation can own an entire business and pay no excess holdings tax under a narrow exception in Section 4943(g), added in 2018. The arrangement is aimed at situations where a business exists to fund a foundation rather than the reverse. Every one of these conditions must be met:²

The foundation acquired all of its ownership interests by gift or bequest, not by purchase.
The foundation holds 100% of the voting stock at all times during the tax year.
The business distributes an amount equal to its net operating income to the foundation within 120 days after the close of its tax year.
No substantial contributor to the foundation, or family member of one, serves as a director, officer, employee, or contractor of the business.
A majority of the foundation’s board consists of people who are neither officers or directors of the business nor family members of a substantial contributor.
The business has no outstanding loans to substantial contributors or their family members.

The independence requirements catch most attempts. A founder who donates a company and then stays on as its CEO disqualifies the entire arrangement.

How Long You Have to Sell

Divestiture windows depend on how the excess holdings arose in the first place.

Gifts and Bequests: Five Years

When business interests arrive by gift, bequest, or certain corporate readjustments that push the foundation over the limit, the law treats those holdings as permitted for five years.¹ No excise tax accrues during that window. The clock starts when the foundation actually receives the property, not when the donor died or signed the gift documents.⁶ For bequests, that usually means the date the estate distributes the asset.

One additional five-year extension is possible through a private letter ruling. The foundation has to show it made genuine sale efforts during the initial period but could not sell except at a price substantially below fair market value, because of the size or complexity of the holdings.⁷ A detailed divestiture plan has to be submitted to both the IRS and the state attorney general before the initial period ends. Foundations that wait until the final months to start marketing the asset will struggle to justify the extension.

Other Changes: 90 Days

When excess holdings arise from something other than the foundation acquiring the shares itself, for example a third-party stock redemption that pushes up the foundation’s proportionate ownership, the excise tax is suspended for only 90 days from the date the foundation knows or has reason to know about the change, and only if the excess is disposed of by the end of that period.⁸ Because ownership can shift without the foundation doing anything, this grace period rewards foundations with monitoring systems that flag corporate actions quickly.

Selling Without Triggering Self-Dealing

The obvious buyer for a closely held business is often the family that runs it, but selling foundation property to a disqualified person is itself an act of self-dealing under Section 4941 and carries its own excise taxes. The buyer has to be someone who is not a disqualified person, which can significantly narrow the market for family-company shares.

One safety valve helps. Transactions occurring as part of a corporate liquidation, merger, redemption, or other reorganization are not treated as self-dealing when two conditions are met: all securities of the same class are subject to the same terms, and the foundation receives no less than fair market value for its shares.⁹ A company-wide stock redemption at appraised value can clear this hurdle even if the company is controlled by disqualified persons. An independent appraisal documents the fair market value requirement.

The 10% and 200% Excise Taxes

The penalty runs in two tiers, and the gap between them is designed to make delay financially untenable.

The first-tier tax is 10% of the value of the foundation’s excess holdings for each tax year ending during the taxable period.¹ Value is measured on the single day during the year when the excess was at its greatest. The taxable period begins on the first day the foundation has excess holdings and ends when the IRS mails a notice of deficiency or when the tax is assessed, whichever comes first. The tax is reported on Form 4720.¹⁰ Correcting the problem by selling to a non-disqualified person stops the tax from accruing further, though amounts owed for prior years remain due.

The second-tier tax is 200% of the value of any excess holdings still on the foundation’s books at the end of the correction period, which generally runs through 90 days after the IRS mails a notice of deficiency for that tax.¹ At that rate the tax can exceed the value of the shares themselves, which is the point: it removes any economic incentive to absorb the 10% annually and keep the business indefinitely.

Beyond Form 4720 for the tax itself, every private foundation addresses excess business holdings annually on Form 990-PF, using Schedule C of Form 4720 to run the calculation.¹¹ Foundations that believe they are comfortably within the limits should still do the math each year. Changes in disqualified persons’ personal holdings, or in the company’s capital structure, can create an excess without the foundation taking any action.

1
Office of the Law Revision Counsel. 26 USC 4943 – Taxes on Excess Business Holdings
2
Office of the Law Revision Counsel. 26 USC 4943 – Taxes on Excess Business Holdings
3
Internal Revenue Service. Functionally Related Business
4
Office of the Law Revision Counsel. 26 USC 507 – Termination of Private Foundation Status
5
Office of the Law Revision Counsel. 26 USC 4946 – Definitions and Special Rules
6
eCFR. 26 CFR 53.4943-6 – Five-Year Period to Dispose of Gifts, Bequests, Etc.
7
Internal Revenue Service. Reducing Private Foundation Excess Business Holdings: Additional Time to Dispose of Large Gifts or Bequests
8
eCFR. 26 CFR 53.4943-9 – Business Holdings; Certain Periods
9
Office of the Law Revision Counsel. 26 USC 4941 – Taxes on Self-Dealing
10
Internal Revenue Service. Instructions for Form 4720
11
Internal Revenue Service. Form 990-PF, Return of Private Foundation