Bypass Self Dealing Rules

Transferring assets from an estate to the decedent’s private foundation (PF) may inadvertently trigger self-dealing issues.  A recent Private Letter Ruling illustrates the application of the “estate administration exception” to the self-dealing rules, in the context of a note issued in conjunction with prior sale to an irrevocable trust.

In this ruling, the decedent sold an interest in his company to an irrevocable trust for a note.  Under his will and revocable trust document, the note would pass to several beneficiaries including his PF. 

The Internal Revenue Code imposes a self-dealing excise tax on certain transactions between a PF and a disqualified person.  Since the decedent’s revocable and irrevocable trusts fit the definition of disqualified person, the PF’s receipt of the not and any subsequent payments of principal and interest from the irrevocable trust to PF would have constituted self-dealing. 

To overcome self-dealing, the executor proposed to exchange the note for cash and non-voting shares in newly formed limited liability company (LLC) and distribute the cash and non-voting LLC interest to the PF.  Consequently, the PF would receive payments of principal and interest from the LLC, as it receives such payments from the irrevocable trust; meeting the five requirements for the estate administration exception. 

The IRS concluded that the exercise of the executor’s power to do this satisfied the requirements for the exception to self-dealing.  Additionally, the LLC’s retention of the note, receipt of payments on the note and distributions of such payments are not acts of self-dealing. 

See Julia Chu, Avoid Violating Self-Dealing Rules, Wealth Management, Dec. 2, 2014.

Special thanks to Jim Hillhouse (Professional Legal Marketing (PLM, Inc.)) for bringing this article to my attention.