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Download the 2023 Fall Newsletter

In this Issue:

• Circuit Split on Inclusion of Life Insurance Proceeds in Valuation of Closely Held Business Subject to Stock Redemption Agreement written by Andrew J. Barron
• What's in a Name? The steps transgender individuals need to make to change legal names on accounts and estate planning documents written by Brittany Cook
• Lies, Damn Lies and Illustrations written by Michael DeFillipo
• Artificial Intelligence ("AI") in Estate Planning - Challenges and Opportunities written by Victor S. Levy and Eric DeSouza
• From the NAEPC Engagement Committee written by Kim V. Heyman and Tim Zeigler

Written by Jeffrey D. Haskell, J.D., LL.M., and Jennifer Bruckman-Gorak

Although it’s well known that a private foundation (“PF”) can freely make grants to Internal Revenue Code (“IRC”) Section 501(c)(3) public charities, many are surprised to learn that a PF may make a grant to a for-profit organization (“FPO”) by satisfying certain requirements. Due to the potential for the enrichment of private interests, however, a PF must contend with an added layer of complexity when granting to an FPO: the need to conduct a private benefit analysis, as the presence of substantial private benefit can subject the PF to a 20% penalty on the grant. This article will provide an analytical framework to help a practitioner gauge whether the private benefit concern posed by a PF’s grant to an FPO poses a threat and, if so, guidance as to how it might be overcome.

As a starting point, it’s critical that the PF identify a sufficiently large group of individuals—a broad charitable class —that it intends to benefit through a grant to an FPO. After all, the FPO itself is not the intended beneficiary; it is merely the instrument used by the PF to achieve its charitable objectives. For instance, if the PF were to make a grant to an FPO caterer to provide free meals to children attending a particular school in a disadvantaged neighborhood, the children, not the caterer, would be the intended beneficiaries of the PF’s largesse.

Additionally, the PF must consider the degree to which the grant serves the private interests of the FPO and others who will benefit from the grant, even though they are not part of the charitable class that the PF intends to benefit (in other words, the unintended beneficiaries). This requirement stems from the private benefit doctrine embodied in IRC Section 501(c)(3), which provides that PFs and other charitable organizations must be operated exclusively for charitable and other exempt purposes. Specifically, Treasury Regulations (“Reg.”) § 1.501(c)(3)-1(c)(1) provides that an organization will be regarded as operated exclusively for exempt purposes unless more than an insubstantial part of its activities is in furtherance of a non-exempt purpose. Further, Reg. § 1.501(c)(3)-1(d)(1)(ii) adds that an organization is not organized or operated exclusively for exempt purposes unless it serves a public rather than a private interest. Thus, an organization’s exemption may be lost if it serves a private interest to a more than insubstantial degree, although there is no bright-line test to make such determination.

The ability to make such a determination is also key in avoiding a penalty when making a grant to an FPO. The Regulations specifically address activities that could cause a PF to lose its charitable status if such activities were a substantial part of the PF’s total activities. If a PF makes an expenditure for such an activity, Reg. § 53.4945-6(a) provides that the PF will be subject to a 20% taxable expenditure penalty. Since the presence of a private benefit can cause a PF to lose its charitable status if it were a substantial part of its overall activities, it follows that a grant conferring a substantial private benefit also may be subject to a taxable expenditure penalty. The key is knowing when a private benefit is merely insubstantial and, therefore, permissible.

As noted by Mancino and Hill, the IRS “has taken the position that insubstantial is properly understood as an “incidental” amount and that the position that whether an activity is incidental will be tested on both qualitative and quantitative grounds.” To be deemed qualitatively incidental, the primary benefit must flow to the public at large and any benefits to private interests must be a necessary concomitant to achieving the organization’s charitable objectives. The qualitative test is illustrated by Rev. Rul. 70-186, in which an organization was formed to improve the condition of the water in a lake that was available to the community as a recreational facility. While the improvement would benefit the public at large, it also would benefit the owners of lakefront property by increasing property values. The IRS concluded that the private benefit was incidental in a qualitative sense because the benefits would flow to the general public, and such benefits could not be attained without necessarily benefitting the private property owners.

When making a grant to an FPO, a PF must apply the qualitative test to both the intended and unintended beneficiaries of the activity conducted by the FPO, as well as to the FPO itself. For instance, consider the school meal program discussed above. There, the PF should consider whether the benefit will reach the needy children (the intended beneficiaries) and whether the benefit provided to the other children who will receive the meals even though they are not in need of them (the unintended beneficiaries) is an unavoidable byproduct of the program. Suppose that the school insists on providing the meals to all children because it would be administratively burdensome to keep track of those who would not qualify for the program, as nearly all would be eligible. In that case, the benefits to the small group of unintended beneficiaries would be a necessary byproduct of the program.

Similarly, conferring a benefit upon the FPO likely would be unavoidable if the PF exercised reasonable judgment in determining that its charitable goals would be best achieved through an FPO. In any event, a PF should not be compelled to choose a less effective option for achieving its charitable purposes just because that other option might confer a lesser degree of private benefit. For example, while a loan or equity investment provides a lesser degree of private benefit than a grant because the PF stands to recover its investment, a grant may still be the best option because the FPO may not earn sufficient revenue to service debt or pay dividends, and a PF investment may deter commercial investors. Further, an FPO might be the best choice because of superior experience, track record, qualifications, lower cost, higher quality, etc., even if a charity also could carry out the program, albeit not as well. However, in the unlikely event that an alternative option would be equally effective while conferring less private benefit than a grant to an FPO, one may infer that the PF should choose that alternative in order for the private benefit to be qualitatively incidental. After all, to the extent that private benefit can be reduced, but isn’t, the portion of the private benefit that could have been avoided, but wasn’t, can’t be considered a necessary byproduct of the activity.

Additionally, as noted above, an activity must be quantitatively incidental, requiring the application of “a comparative standard in which the private benefit is measured against the specific public benefit provided.” In weighing the private against the public benefit, the IRS has acknowledged that the degree to which private benefit will be tolerated will vary in proportion to the degree of public benefit conferred. This principle is illustrated in Rev. Rul. 76-152, where an organization was established to promote community understanding of modern art trends. The organization selected modern art works of local artists for exhibition and sale at its gallery. Upon sale of an artwork, the artist received the sales proceeds after paying a ten percent commission to the organization. Noting that the artists were not members of the charitable class intended to benefit from the activity, the ruling concluded that the private benefit to the artists could not be overlooked as being merely insubstantial in relation to—and despite—the public benefit conferred by the exhibitions.

In applying the quantitative test to an FPO grant, the PF must weigh any private benefit conferred upon the grant’s unintended beneficiaries against the public benefit. Of course, the larger the charitable class, the greater the number of intended beneficiaries who are likely to be reached, and the greater the benefit to the intended beneficiaries, the more likely the public benefit will outweigh the private benefit. Another way to tip the scale in favor of public benefit would be to minimize the private benefit as much as possible. In fact, an implied imperative to minimize private benefit can be found in IRC § 501(c)(3), which expresses the ideal of an organization’s operating exclusively for charitable purposes. Although the Regulations clarify that an incidental amount of private benefit may be tolerated, a PF nevertheless should conform as closely as possible to the IRC’s ideal.

Referring back to the example with the school meal program in a disadvantaged neighborhood, local demographics should ensure that the number of intended beneficiaries would greatly outnumber the unintended beneficiaries. Therefore, one may readily conclude that the private benefit in this scenario is quantitatively incidental because the public benefit outweighs the private benefit. By contrast, had the program been conducted in an affluent neighborhood, the private benefit could have been minimized by limiting program eligibility to those in need.

Additionally, the quantitative test must be applied to the FPO itself. Here, too, the PF should strive to minimize the benefit to the FPO to increase the likelihood that any private benefit will be outweighed by the public benefit. However, a PF should employ a different approach for minimizing the FPO’s private benefit, given its unique role as the PF’s instrument for carrying out its charitable objectives. Namely, the PF should avoid granting more than a reasonable amount in exchange for the value furnished by the FPO in terms of goods, services, and other tangible benefits. If the PF does not negotiate fair value in exchange for the grant, as required by the ongoing fiduciary duty of care, the ensuing private benefit to the FPO may outweigh the grant’s public benefit. For instance, referring back to our example, suppose that the going rate charged by other caterers for the same meals is substantially less than the grant paid to the FPO. In that case, the PF’s substantial overpayment for the value received could cause the private benefit to the FPO to outweigh the public benefit.

In GCM 37789, the Office of the Chief Counsel reasoned that private benefit would be merely incidental if a nonprofit hospital were to lease land to physicians at market value and provide financing to them at the prevailing rate for the construction of a medical building on such land. The GCM noted that, as originally proposed, the hospital would have leased the land at virtually no cost to the physicians, resulting in a more than incidental quantitative private benefit because it may well have outweighed the benefit to the public at large. In this vein, the GCM noted that while the financing arrangement at market rates was not problematic, it would have been “troublesome” if the hospital were to lend its funds at less than market rates.

Finally, Reg. § 53.4945-6(b)(2) supports the conclusion that paying fair value to an FPO for goods, services, or other tangible benefits should not give rise to a substantial private benefit. Generally, this regulation provides that an expense payment in excess of fair value may be subject to a taxable expenditure penalty unless it is paid in the good faith belief that such expense was reasonable and is consistent with ordinary business care and prudence. As with the private benefit analysis, the determination as to whether an expenditure is reasonable will depend on the particular facts and circumstances of each case.

In determining whether a grant to an FPO would result in impermissible private benefit, a PF would be well advised to thoroughly document its reasoning. The answers to the following questions can assist a PF in documenting its reasoning in ruling out an impermissible private benefit that could expose the PF to a penalty:

• What is the charitable purpose served?
• Describe the “broad charitable class” that will benefit from the PF’s grant.
• In the judgment of the PF’s board, is the FPO the best vehicle for achieving the PF’s charitable purposes? If so, why?
• If the FPO is the best vehicle for achieving the PF’s charitable purposes, is a grant the best means of providing funding to the FPO in the judgment of the PF’s Board, as opposed to a loan or equity investment? If so, why?
• With respect to the qualitatively incidental test, is the private benefit, if any, a necessary byproduct of an activity that benefits the public at large?
• With respect to the quantitatively incidental test:
• Does the public benefit outweigh the private benefit? If so, why?
• Is the program designed to target the grant’s intended beneficiaries to the greatest extent possible while minimizing benefits to unintended beneficiaries? If so, how?
• Is the PF receiving at least fair value in terms of goods, services, and other tangible benefits (to be provided by the FPO to the intended beneficiaries) in exchange for the amount of the grant? What is the basis for this conclusion?
• If the goods and services received for the grant constitute less than fair value, has the PF obtained other concessions from the FPO? If so, what concessions were gained?

Although using an FPO as an instrument to advance a PF’s charitable purposes adds a layer of complexity, more and more PFs are expressing interest in this unique approach. Indeed, working through an FPO can certainly be a highly effective option for accomplishing a PF’s charitable purposes, so long as the PF exercises business judgement and thoughtfully analyzes the private benefit concerns.

Click here to download the article with footnotes.

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Jeffrey D. Haskell, J.D., LL.M., is chief legal officer and Jennifer Bruckman-Gorak is deputy legal officer for Foundation Source, which provides comprehensive support services for private foundations.

Written by Michael Mallick and Ryley Harper, Valley Forge Financial Group

History & Current Legal Landscape

With the passage of the Marijuana Tax Act in 1937, a tax was placed on the sale of cannabis that quickly criminalized it and classified it as a Schedule 1 Controlled Substance. Almost 60 years later, the state of California passed Proposition 215 in 1996 by a 56% vote to permit the use of marijuana for medical treatment recommended by a physician. Today, nearly 80% of US States have passed legislation approving either the recreational or medical use of marijuana or both, with 20 states passing approvals in just the last five years.

US States + District of Columbia

• Recreational & Medical Use Approved: 22 (43%)
• Medical Use Approved: 18 (35%)
• No Uses Approved: 11 (22%)

According to a 2021 national survey performed by the Substance Abuse and Mental Health Services Administration (“SAMHSA”), almost 20% of adults reported using marijuana the prior 12 months. As the legal landscape and potential social stigma around marijuana use continues to evolve, the underwriting for life insurance is quickly evolving. However, the changes varies by insurance carrier and depend on the type and frequency of use. In this article, we hope to answer several questions surrounding the impact of marijuana use on securing life insurance coverage.

Can I get life insurance if I use cannabis in any form?

Obtaining life insurance coverage with disclosing or evidence of marijuana use is possible. However, as with many things…it depends. The major factors that determine underwriting class are:

• Admission of Use
• Lab Results for THC
• Reason for Use
• Frequency of Use
• Delivery Method
• Age
• Additional High-Risk History

An insurance carrier will assess an underwriting class based upon the medical history and disclosures provided by an applicant. Each risk class is designed to assess a fee or charge for a given level of risk or probability of life expectancy. An applicant’s risk class, product, age and gender are used to determine the cost of insurance for a given level of death benefit. The cost for each risk class can vary substantially across each level. The table below illustrates the percentage increase in premium when compared to the best available underwriting risk classification amongst non-smoker and smoker rates:

Admission of Use

Insurance underwriters do not look favorably if usage is not disclosed on the written application and instead uncovered through other sources such as lab results, medical records, or prescription drug history. If a policy is issued and a death claim is submitted during the two year Contestability Period, a life insurance carrier may investigate the claim and potentially deny it if false or misstatements were made on the application. On the other hand, a positive Tetrahydrocannabinol (“THC”) lab result with a documented reason and disclosures for marijuana use may still qualify for Non-Smoker Best rates.

Reason for Use

Medical usage of marijuana is viewed more favorably than recreational use. An applicant with a valid prescription card, details of their underlying medical condition and treatment plan can qualify for Best to Preferred rates. However, an underwriter will also review and rate the underlying medical condition separately, which could result in a reduced rating. Recreational use is acceptable for applicants where marijuana has become legalized however the rating class would be determined based on the frequency of use.

Frequency of Use

The frequency of use of marijuana is one of the biggest determining factors of rating and/or an offer of coverage. Mild usage, defined as up to 2x per month, could qualify for Preferred or Best rates. Medium usage, defined as up to 10x per month, could qualify for Standard rates. In most cases, heavy usage, defined as 25x per month or daily would be Table Rated or Declined coverage with exceptions made for certain medically prescribed cases. Even if frequency is high, non-smoker rates are available within each classification depending on delivery method.

Delivery Method

Smoking THC more than 1x per month will result in Smoker rates in addition to the underwriting class designated. Some carriers differentiate between smoking and vaping by qualifying vaping as a Non-Smoker classification. Ingesting marijuana in an edible form will avoid Smoker ratings and the underwriting class will be predominately determined by the frequency reason of use. Additionally, Cannabidiol (“CBD”) oil use has become a very popular delivery method and is different than THC.

Some of the differences between THC and CBD are as follows:

THC

• Controlled substance and psychoactive
• Effects: Stimulates appetite, Euphoria, Drowsiness
• Marijuana plant is used (THC content between 15-20%)

CBD

• Not a controlled substance or psychoactive
• Effects: calming, relaxing, supporting well-being, healing
• Hemp plant is used (THC content is less than 0.2%)

Insurance carriers qualify CBD oil users as Non-Smokers regardless of delivery method or frequency.

Age

Insurance underwriters may view marijuana usage for older applicants more favorably than younger applicants. In many cases, those under age 30 with documented or admitted marijuana use, could achieve no better than Standard rates. Applicants over this age may qualify for Preferred to Best rates subject to type and frequency of use.

Other High-Risk History

Regardless of the specific details of marijuana use, the following criteria also would be considered and would typically result in a decline in coverage:

• Business owners, executives, and employees in the marijuana industry
• Additional current or historical alcohol or drug abuse
• Criminal history
• Motor vehicle driving record with violations
• Mental health conditions
• Aviation activity

Recommendations

The underwriting manuals at each of the insurance carriers have evolved substantially over the past few years as they relate to marijuana usage. It would have been impossible to achieve Non-Smoker rates with any history of marijuana usage about five years ago but insurance carriers have now greatly liberalized their position. However, there is still substantial variability among the top life insurance carriers. For example, one major insurance carrier will allow usage up to several times per week for best available rates while another carrier would be less lenient and restrict usage to once per month to obtain the best class. When applying for life insurance coverage with marijuana history, it is crucial to clearly document the reasons behind consumption and consult with your independent life insurance professional to obtain the most cost-effective coverage.

Given the different opinions on marijuana between insurance carriers and state regulators, it is ideal to work with an experienced insurance professional who has access to a variety of insurance carriers to conduct due diligence and provide the best insurance solution throughout the market.

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Michael Mallick is the President of the Wealth Transfer practice at Valley Forge Financial Group. He specializes in estate planning, life insurance consulting, business succession and executive benefits.

Ryley Harper is a Wealth Transfer Consultant at Valley Forge Financial Group. He specializes in assisting owners of privately held businesses, high-net-worth families, and their advisory teams with life insurance, estate planning and business succession.

Download the 2023 Spring Newsletter

In this Issue:

• FBAR [Fire Brimstone and Regret] written by Joel S. Luber, Esq.
• Marijuana Usage and the Current State of Life Insurance Writing written by Michael Mallick and Ryley Harper
• Private Foundations Granting to For-Profit Organizations? It's Possible written by Jeffrey Haskill and Jennifer Bruckman-Gorak
• The Corporate Transparency Act: Ready or Not, The Reporting Will Begin written by Kim V. Heyman
• National Association of Estate Planning Councils written by Kim V. Heyman and Tim Zeigler

Download the 2022 Fall Newsletter

In this Issue:

• Rising Up - Planning for Higher Interest Rates written by William C. Hussey, II and Franca Tavella
• Maximizing Life Settlement Value Through a Policy Auction written by Jamie Mendelsohn
• The New Uniform Fiduciary Income and Principal Act 
• Econometrics and Estate Planning: A Promising Way to Enhance Outcomes written by Victor S. Levy and Gregory Rothkoff
• From the NAEPC Engagement Committee written by Tim Zeigler

Download the 2022 Winter Newsletter

In this Issue:

• The Smaldino Case: A Lesson on How NOT to Do Estate Planning written by Joel S. Luber, Esq.
• Zeitenwende written by T. Brad Conger, CFA
• Roadmap for Intergenerational Split-Dollar Transaction - Estate of Levine v. Commissioner written by Kim V. Heyman, JD, LLM, AEP
• What is Legacy? written by Clemence R. Scouten
• 2021 PEPC Distinguished Estate Planner

Download the 2021 Fall Newsletter

In this Issue:

• Decanting as an Estate Planning Tool Under Pennsylvania Law written by Samantha Heaton, Esq.
• Florida Community Property Trust - A Great Idea for Fool's Gold written by Alan Mittelman, JD, CLU and Dana Bernstein, Esq.
• Planning for the Future of Artificial Intelligence in Financial Services written by Victor Levy and Josh Eskin
• Life Insurance: 7 Observations from the First 3/4 of 2021 written by Michael C. DeFillipo, CLU, ChFC

Download the 2021 Summer Newsletter

In This Issue:

• A Fresh Look at Revocable Trusts Through the Pandemic's Eyes written by Kim V. Heyman, JD, LLM
• McAleer Highlights Division Regarding the Fiduciary Exception to the Attorney-Client Privilege written by Richard Holzworth, Esq. and Amanda DiChello, Esq.
• It's All About the Words on Paper: No Substitute for Pinpoint Precision When Drafting Estate Planning Documents written by Joel S. Luber, Esq.
• Ransomeware is Not a Desired App written by Steve McKeon & John Hoyos, MBA

Download the 2021 Winter Newsletter

In This Issue:

• Mentoring and How to Do It at Home written by Robert H. Louis, Esq.
• Power of Appointment - Best Thing Since Sliced Bread written by Joel S. Luber, Esq.
• Consolidated Appropriations Act of 2021 Update: Your Clients May Call You About These Changes written by Rachel M. Kieser, CPA, MT
• A Wait-and-See Legacy Planning Approach: Maintain Flexibility While Getting a Foot in the Door written by Michael C. DeFillipo, CLU, ChFC
• Explaining the Accredited Estate Planner Designation written by Tim Zeigler

 

Download the 2020 Fall PEPC Newsletter

In This Issue:

• Musings in a Postpandemic World written by Mark McGlone and Michael Moyer
• How the 2020 Elections and Ongoing Pandemic Can Impact Your Estate Plan written by William Hussey, II and Franca Tavella
• Pennsylvania Enacts the Revised Uniform Fiduciary Access to Digital Assets Act written by Jennifer Zegel, Esq. and Karen A. Fahrner, Esq.
• The Impact of COVID-19 on the Life Insurance Industry written by Michael C. DeFillipo, CLU, ChFC
• NAEPC and NAEPC Annual Conference written by Tim Zeigler