A (Lite) Defense of Newman’s Own
Newman’s Own Foundation is facing a massive tax bill at the end of this decade if it doesn’t sell off shares of its salad dressing, sauce, and snack empire and can’t convince Congress to change section 4943. Bills pending in the House and Senate would save Newman’s Own from having to divest. Brian blogged about this last week and made a strong argument against amending the Code: “These bills should get moved to the back burner,” Brian writes, “and shame on Newmans for prioritizing the interests of the Newman heirs over good philanthropy.”
Maybe I’m letting my affection for Newman’s Own marinara pasta sauce skew my tax policy judgment, but I actually think that Newman’s Own has a point here. Perhaps we shouldn’t be so worried about private foundations owning business enterprises, and the section 4943 tax on excess business holdings may be excessive in its own right.
First, a bit of background. As Brian notes, section 4943 imposes a tax on the “excess business holdings” of any private foundation. The “permitted holdings” of a private foundation in an incorporated business enterprise are (generally) capped at 20% of the voting stock, and anything over that is excess. The statute allows a grace period of 10 to 15 years during which a private foundation must divest its excess holdings; otherwise, the private foundation will face a tax of 10% times the value of its excess holdings in the first year after the grace period and a tax of 200% every year after that until it divests.
Section 4943 dates back to 1969, though it has been amended several times since. As Richard Schmalbeck documents, the initial push for limits on the business holdings of private foundations appears to have been motivated by (1) concerns that enterprises owned by private foundations would put profit-seeking firms in the same industry at a competitive disadvantage; (2) worries that business enterprises would distract foundation managers from their charitable missions; and (3) concerns about self-dealing by foundation managers. Brian’s arguments in favor of section 4943 are slightly different. He says (1) that private foundations tend to be “terrible at running businesses”; (2) that private foundations can gain the “benefits of diversification” by selling off their excess business holdings and investing in a broader portfolio; and (3) that allowing donors to put their business enterprises in a private foundation while leaving their family members in charge amounts to “giv[ing] people tax breaks for doing things they would do anyway.”
Richard Schmalbeck picks apart the original arguments for section 4943 in this 2004 Tax Law Review article, so I’ll focus on Brian’s arguments here (which are also better and more interesting). Before that, though, a quick note on the bills introduced by allies of Newman’s Own to amend section 4943. Each of these bills would leave section 4943 in place but would add an exception when three requirements are satisfied. First, the private foundation must have “exclusive ownership” of the enterprise and must have acquired such ownership under the terms of a will or a testamentary trust. Second, the foundation must donate all profits from the enterprise to charity within 120 days after the close of the taxable year. And third, the business enterprise must be independently operated, which means that no family member of the donor can serve as a director, officer, or employee of the enterprise, and a majority of the private foundation’s board must be composed of individuals other than directors and officers of the enterprise and family members of the donor. (Here is the text of a bill introduced by Senator Orrin Hatch; here is a bill introduced by Senator John Thune; and here is one from Wisconsin Republican Representative Dave Reichert.)
OK, back to Brian’s arguments. To be exempt from section 4943 under the proposed bills, Newman’s Own Foundation would have to hire someone other than a member of the Newman family to run the enterprise. (In fact, it already has.) Should we expect the managers hired by the private foundation to be subpar? Well, that’s not quite the right question: the relevant comparison is between the performance of the enterprise if managed by an outsider and the performance of the private foundation’s portfolio if the foundation sells its excess business holdings and invests the proceeds elsewhere. If we think that private foundations are bad at managing business enterprises, then what’s to make us think that they would be good at managing investment portfolios? (And so too, if we think that private foundations are bad at picking executives to run their enterprises, what’s to make us think that they’ll be good at picking investment managers to steer them toward the right assets?)
As it happens, Newman’s Own appears to have performed quite well over the eight years since Paul Newman’s death. News reports around the time of the actor’s 2008 death indicated that the business holdings Newman contributed to the foundation were worth about $120 million. In its tax filings for 2014, the foundation reported net assets of $210 million. And during the 2008–2014 period, the foundation distributed more than $168 million to charities (i.e., more than 140% of the initial gift). For comparison’s sake, the S&P 500 is up 81% since Paul Newman’s death. The foundation’s salad dressing, sauce, and snack strategy has done quite a bit better than a diversified portfolio likely would have.
To be sure, the Newman’s Own Foundation is bearing a lot of idiosyncratic risk by concentrating its investments in one enterprise. And if Newman’s Own were an individual, that would probably be a bad strategy because individuals are risk-averse. It’s less clear, though, that philanthropic organizations ought to be risk-averse. Risk aversion is generally attributed to the diminishing marginal utility of income: for individuals, it’s a bad bet to put $50 on the line for a 50% chance of winning $100 and a 50% chance of losing it all, because having $100 won’t quite lead to twice as much utility as having $50. But does that hold for philanthropic organizations? Can Newman’s Own do twice as much good with $100 as it can with $50? The answer will depend on the organization. Some charities should even have a preference for risk. (E.g.: If a charity is trying to raise $1 million to save a historic building from demolition, $500,000 won’t accomplish its goal but $1 million will; the charity might even be willing to put $600,000 on the line for a 50% chance of winning $1 million even though that would be a negative expected value proposition from a risk-neutral perspective.) In any event, it’s not clear to me that idiosyncratic risk at the foundation level is always (or even generally) a bad thing.
Finally, consider Brian’s argument that we shouldn’t be giving tax breaks to donors who put their businesses in private foundations so that their family members can remain in control. I very much agree. Note, though, that during his lifetime Paul Newman probably couldn’t use the full value of the charitable contribution deductions he generated through his late-in-life gifts to his foundation, and his widow Joanne Woodward is limited in her ability to benefit from unused charitable contributions carried forward from Paul. More importantly, the Hatch, Thune, and Reichert bills require family members of the donor to relinquish control of both the foundation and the business enterprise. Brian correctly concludes that “[y]ou shouldn’t get a tax deduction for ‘donating’ your family firm, if you are still using the firm to further your own family’s interests.” The bills on the table are designed to prevent exactly that.
To sum up: Newman’s Own is asking for a tweak to section 4943 in order to avoid a hefty tax bill — this is special interest legislation by any measure. But special interest legislation isn’t always bad tax policy, and an exception to section 4943 for Newman’s Own and similarly situated foundations that satisfy the requirements of exclusive ownership, all profits to charity, and independent operation might make some sense.
At the very least, it will make good pasta.