Gift Planning and Endowment

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Monday August 3, 2015

Case of the Week

Lucky Lucy Lindstrom's "Wheeler-Dealer Charity LLC"

Case:

Lucky Lucy Lindstrom finished college and headed west. She started as a financial analyst with a large company in Seattle. After just four years, she became a Registered Investment Advisor and began advising clients. Lucky Lucy also managed her own investments. With her keen insight into financial markets, Lucy soon began to move from traditional stocks and bonds into futures and commodities markets. Lucky Lucy was so successful in these markets that she now manages only her mega-dollar personal portfolio.

Somewhat late in life, Lucky Lucy discovered the wonderful world of philanthropy. She volunteered at her favorite charity and learned that giving someone in need a helping hand is even more gratifying than making another million in the futures market.

Lucy had invested $1,000,000 in stock in a Canadian oil “wildcatter” with the name Northern Long Shot, Inc. This company has been drilling new exploratory wells in the far north. Recently, the stock rose from the $1 per share that she paid to over $5 per share. Lucy was delighted with her gain and decided to give the $5,000,000 to in a supporting organization (SO) with a favorite charity.

For the first two years the SO distributed grants for charitable purposes. By year three, Lucy was so committed to favorite charity that she wanted to increase the annual grants. As a creative investor, Lucy suggested that the SO would start an LLC and jointly invest with Lucy and others in more Canadian oil well developments. She calls the new project the “Wheeler-Dealer Charity LLC.”

With a recent dramatic increase in the price of oil, Lucy has several friends who are eager to participate. She and the SO will each contribute $1 million to Wheeler-Dealer Charity LLC. Total funding will be $10 million. With this amount, Wheeler-Dealer Charity LLC will become a partner in wildcat oil wells. As Lucy says, “The sky is the limit! Profits will soon be gushing forth!”

Question:

Will this plan work? Can the supporting organization be a partner in the oil well venture?

Solution:

Lucy has good intentions, but there are several major problems with this plan. SO is now participating in an active business – drilling for oil. If a charity earns income from a trade or business that it regularly conducts and that trade or business is not substantially related to its charitable purpose, the income is subject to income tax. A charity regularly conducts an activity if the "frequency, continuity and manner" of the activity is similar to that of a for-profit company that conducts the same type of activity. Any activity carried on for the production of income from the sale of goods or performance of services is a trade or business for purposes of applying UBIT. Since the LLC is treated as a partnership, SO under Sec. 512(c) is an active participant in the oil drilling program.

While there are exceptions to the unrelated business taxable income rules, the Wheeler-Dealer Charity LLC does not come within these exceptions. The oil drilling is regular, an active business and not related to the SO exempt purpose. Therefore, any income from the LLC will be UBI to the SO. In addition, if the oil profits become the major source of income, it is possible that the IRS may question the charitable purpose of SO, and even the charitable purpose of favorite charity.

After thinking through these risks to SO and favorite charity, Lucy decided to set up the LLC herself. She and her friends did invest in Canadian oil wells. With the substantial profits from the LLC, Lucy continues to make gifts to SO. Her favorite charity is delighted to cash those checks and send Lucy a warm thank you note.

Published July 31, 2015

Previous Articles

Lucky Lucy Lindstrom's "Personal Loan" Charity

Lucky Lucy Lindstrom's "Cousins' Scholarship" Plan

Lead to Remainder Double Charitable Trust

Lucky Lucy Lindstrom's Long Shot Unitrust

Lucky Lucy Lindstrom's Unitrust

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