Originally published on Forbes.com.
Chan Zuckerberg Initiative LLC is now probably the most famous LLC ever. In case you have been hiding out for the last couple of days, I should tell you that CZI LLC is the vehicle that Mark Zuckerberg and Dr. Priscilla Chan will be using to fulfill their promise to their new daughter Max they made in an open letter which you can find on Facebook (go figure). Their promise is to donate almost all their Facebook stock to charity during their lives.
According to CZI’s Facebook site, it was launched in 2009 to “advance human potential and promote equality”, but as a legal entity, which is what a limited liability company is, it was formed on November 24, 2015 in Delaware with Corporation Service Company of Wilmington as its registered agent. (That’s important to know in case you want to sue them about something).
Frankly, there has been so much coverage on this, that I was inclined to pass, but since in all the coverage I have not seen any discussion of the check-the-box regulations, and I don’t think that tax geeks should let this moment of attention to the limited liability company pass without noting that there have been times when things were actually simplified.
Limited Liability Companies
Back in the day, the day being before 1997, it was really hard to have a flow-through entity that had limited liability. S corporations were limited in the number of shareholders and who could be shareholders. More significantly for tax shelters, the shareholders in an S Corporation were not deemed to have basis in the entity’s liabilities. Also everything had to be done on a per-share basis – no special allocations.
Limited partnerships were the thing to use if you wanted flow through and limited liability. There was a problem though. In order for the limited partnership to not be treated as an association taxable as a corporation, the general partner had to have unlimited liability. Of course clever people would have a corporation be the general partner, but the IRS was onto that and required the corporation to have some net worth if you wanted a ruling that your limited partnership was not an association taxable as a corporation.
In 1977 Wyoming passed the first modern LLC statute in the United States (There were precedents, but let’s not go crazy here with the history). There was an argument that even though the entities provided limited liability they were not associations taxable as corporations. If you are doing transactions that are tax sensitive though you want a sure thing, so the limited partnerships stuck around. Finally in 1997 the IRS issued the “check-the-box” regulations which were a marvel of simplification.
Check-The-Box
Basically, if an entity is not legally a corporation, it will not be treated as an association taxable as a corporation, unless you want it to be. A domestic entity with one owner defaults to an entity that will be disregarded for income tax purposes and an entity with more than one owner defaults to a partnership. It can elect to be taxed as a corporation. You do that on Form 8832. (It is a similar deal with foreign entities, although they default to corporation status and it can be a bit of a puzzle as to whether a particular type of foreign entity is eligible to elect partnership status or per se a corporation). Another little wrinkle in all this is that a couple in a community property state that are the only owners can treat the entity either as disregarded or as a partnership.
So the bottom line of all of this is that CZI LLC might have no required federal income tax filing at all. Or it may file a partnership return, which will flow through to Mr. Zuckerberg and Dr. Chan (assuming they are the only members).
So What’s All The Fuss About?
All this has professionals scratching their heads a bit about the excitement. This morning Paul Streckfus wrote something titled “Much Ado about Nothing?”
It’s taking the popular media by storm. Facebook founder Mark Zuckerbergand his wife, Priscilla Chan, are giving away most of their wealth — estimated at $46 billion — to charity — or are they? Opinions seem to be divided in part because they are using a limited liability company as the vehicle, not a private foundation or a trust. The charitable pledge, or whatever it is, will be to the Chan Zuckerberg Initiative LLC. Will this LLC be seeking and accorded tax-exempt status?
The rules for LLCs in the tax-exempt area can be confusing, at least to me.
If it is confusing for Paul, it is impossible for ordinary mortals. So I’m thinking it is unlikely that the LLC will apply for exempt status.
Tim Speiss who heads the Personal Wealth Advisory group for EisnerAmper talked with me yesterday. He explained quite a bit about the disclosure and reporting that the couple would have to deal with if they transferred their stock to a foundation. If you want a feel for it you can check out the Form 990-PF of the Bill & Melinda Gates Foundation Trust with its over $40 billion in assets. In 2013 it received over $2 billion from Warren Buffett, who thereby avoided the tsoris of creating his own foundation.
So I tried to hone in with Tim on what the point of forming the LLC was. He indicated that some people cycled their charitable contributions through LLCs for purposes of anonymity. In order to be able to deduct charitable contributions over $250 you need an acknowledgment from the charity. Of course, that is not what is going on here. Why couldn’t the Chan Zuckerberg Initiative just keeping chugging along as a kind of d/b/a for whatever the couple felt like doing? It is all pretty speculative, but one thing Tim mentioned is that his ultra-high net worth clients will hire teams of experts to direct their philanthropic efforts.
The Bill & Melinda Gates Foundation, for example, in 2013 paid Joseph Cerrell $1,313,088 to serve as a director for Europe, Grindree Beeharry $866,484 for India and Ray Yip $788,712 for China. All in there is over $180 million in salaries being paid with over $3.3 billion in grants being made.
That sort of payroll is not something that you want to be running through your personal checking account. So if Mr. Zuckerberg and Dr. Chan are going to be building some sort of infrastructure for their good works, it makes sense to have some sort of a legal entity. By using an LLC, the tax reporting can end up, as if they are doing everything themselves.
Who Needs Charitable Deductions?
As others have pointed out, transferring assets to an LLC will not result in a charitable contribution, but frankly the couple probably does not have much in the way of income tax issues. Zuckerberg draws a $1 salary from Facebook. If Dr. Chan practices full time, she might make in the vicinity of $200,000. Zuckerberg has the ultimate tax shelter in the form of unrealized appreciation. He only has to sell enough stock to fund his lifestyle, which by all accounts is very modest. If he were really allergic to paying taxes, he could borrow to pay his living expenses. (See Note)
What About An LLC For You?
A lot of the techniques that are used by the ultra-wealthy are not really applicable to ordinary mortals, but the LLC does not fall in that category. If you are starting a venture of some sort and want a wrapper around it that creates some legal shield (you need to ask your lawyer how good the shield is), a LLC might well be your best option. It doesn’t need to cost you more than a couple of hundred bucks, maybe less, and you can unwind it with no income tax consequences if you choose.
Note
As I was thinking about this more, I realized that Zuckerberg likely has substantial income from the $1 billion that he took in from the initial IPO. Just for talking purposes say it is $50 million, which would be a lot of realized income if he is invested for growth. Charitable contributions of appreciated property are limited to 30% of adjusted gross income and overall charitable contributions are limited to 50% of adjusted gross income. There is a five-year carryover. So if the couple gives away $1 billion worth of stock next year, it could conceivably yield less than $100 million in charitable deductions, better than getting poked in the eye with a sharp stick, but not in proportion to the gift. If they follow through on their plan, they will probably always have more charitable deductions than they can use.
Very large gifts of appreciated profit and a net worth predominately of unrealized appreciation produce somewhat peculiar results. You might want to check out this piece on Warren Buffet’s return.