Estate Planning for the Wealthy – 501(c)(4)

Take-Away: For the uber-wealthy, there is a new estate planning vehicle for them to consider- the creation of a social welfare organization under IRC 501(c)(4).

Background: We are all familiar with a 501(c)(3) publicly supported non-profit charitable organization. Contributions to a 501(c)(3) are tax deductible. Only  a 501(c)(3) organization can receive qualified charitable distributions from an IRA. Less well known, though,  is the 501(c)(4) social welfare organization.

• Organizations: Several reputable companies and organizations have formed 501(c)(4) [for ease of reference they are referred to as C-4’s]. Examples include: Planned Parenthood, AARP, Kiwanis, Rotary International, Lions Clubs, and various volunteer fire departments across the country.
• Families: More recently families have begun to form C-4’s The Koch family recently transferred $1.2 billion to its C-4 in 2020. And last fall, the C-4 became headline news when the owner of Patagonia, Yvon Chouinard, donated $3 billion of his company stock his C-4. Chouinard gave 98% of Patagonia to Holdfast Collective, a new C-4. That C-4 will hold the Patagonia business stake indefinitely, while 2% of the company shares- and all of Patagonia’s voting stock,  will be held in the a family controlled trust “to protect the company’s values.” Thus, with the formation of this C-4, the Chouinard family:  (i) stays in control of the company; (ii) the company is managed for profit; and (iii) the profits go, not to the Chouinard family (who probably do not need the money), but to support environmental projects and climate advocacy which are important to Mr. Chouinard. It is estimated that Holdfast Collective will receive roughly $100 million annually through its ownership of Patagonia.

Short C-4 History: Back in 2010, the U.S. Supreme Court in its Citizens United v. FEC decision allowed corporations and labor unions to register as C-4s and thus authorized unlimited spending on politics with undisclosed donors through the C-4’s political action committees (PACs.) Then, in 2015, IRC 501(c)(4) was tweaked by Congress to make it clear that the transfer of assets to a C-4 structure was not subject to the 40% federal gift tax. For a billionaire, avoiding that federal transfer tax becomes a prerequisite for dynastic wealth planning.

Why Use C-4 Organization?: The key is control. Continued control over the billionaire’s business, political influence though donations to political campaigns, few public disclosures, avoiding income taxes, and a device for focused charitable giving. Mr. Chouinard is quoted as saying that his C-4 “is the ideal vehicle for grantmaking” with considerable flexibility since a C-4, unlike a 501(c)(3) organization, avoids the traditional rules associated  with charitable giving. And a C-4 can opt out of the transparency requirements that are imposed on family foundations.

• Income Taxes: Unlike Contributions to a 501(c)(3) organization, there is no charitable income tax deduction available to the donor who forms the C-4. However, the absence of a charitable income tax deduction is not much of a factor when you consider that charitable income tax deductions are capped at a portion of the donor’s income. More important to the wealthy donor to a C-4 is the ability to avoid capital gains taxes on the wealth that is generated. The income earned by the C-4 is tax exempt.
• Excess Business Holdings: Many owners of illiquid private companies are attracted to C-4’s because of the so-called excess business holding rules. Most private foundations cannot own more than 20% of one company. Thus, a C-4 is particularly appealing to a business founder who does not want to disengage from his/her life’s work reflected by the business that they formed and grew. Which leads to the potential of a C-4 holding an entire business, e.g. Patagonia.
• Estate Taxes: The entire value of the donor’s business can be removed from their taxable estate without any transfer tax imposed.

Limitations: Compared to a 501(c)(3) organization, there are few limitations imposed on a C-4. Those restrictions include: (i) the donor to the C-4 cannot take the money or assets back, i.e. their gift is irrevocable; and (ii) the direct spending by a C-4 on elections cannot be the C-4’s primary purpose, but no rule or Regulation defines (or limits) what constitutes its primary purpose. If less than half of the C-4’s income is spent on political campaigns, e.g. 48%, does that satisfy this limitation?

Compare to 501(c)(3): A 501(c)(3) is prohibited from supporting or opposing candidates for public office and it must engage only in nonpartisan activities.  A C-4 can engage in some partisan activity but, as noted, political activity cannot be its primary purpose. Campaign contributions (cash or in kind) are prohibited for federal candidates, but are permissible in some states. A C-4 can advocate for causes and propositions, like a 501(c)(3), but only it can endorse specific candidates, e.g. political action groups to advance reproductive or civil rights. In short, a C-4 is allowed to become far more politically involved and partisan, including its ability to lobby for or against legislation.

Affiliate C-4’s: Some well-known non-profit organizations like Planned Parenthood, AARP, the ACLU, all of which are 501(c)(3) organizations have formed affiliate C-4 organizations to enable them to become actively engaged in political campaigns and to support, or oppose,  political candidates for office.

Congress is Watching: A vocal critic of the C-4 and its growing influence in politics is U.S. Senator Sheldon Whitehouse of Rhode Island. In his view the C-4 is “and increasingly powerful tool for mischief.” His concern is that a C-4 gives a billionaire a tax advantaged way to exert secret influence over elected officials, by spending unlimited amounts on political lobbying and in election campaigns.

Conclusion: While individuals are often motivated to give to charities in order to obtain a charitable income tax deduction, it is important to remember that not all donors look to, or can use, a charitable income tax deduction. Which may explain why a 501(c)(4) social welfare organization may appeal to an extremely wealthy individual to minimize their exposure to federal estate taxes yet retain flexible control over their life-long business. That certainly was the motivation for Yvon Chouinard who gave away almost all of his stock in Patagonia to Holdfast Collective while enabling him to pursue his passion of saving the environment.