Taxagonia

by Paul G. Rando*

I. Introduction

“Earth is now our only shareholder,” announced Yvon Chouinard, founder of the $3 billion outdoor apparel company Patagonia, in a September 14 letter.¹ Chouinard went on to outline a plan to transfer his and his family’s ownership of the company almost entirely to a trust tasked with maintaining Patagonia as a profitable business, the profits of which will be invested in a 501(c)(4) nonprofit tasked with fighting climate change.² “I am dead serious about saving this planet,” Chouinard wrote.³ Despite Chouinard’s professed philanthropic motive, the move immediately came under fire from critics who claimed Chouinard was avoiding taxation⁴ and shamelessly exploiting the Internal Revenue Code (the “Tax Code”).⁵ This Article examines the shift, discusses tax-based criticisms of it, and finally responds to the criticism.

II. Background

A. Patagonia’s New Clothes: the 501(c)(4) Nonprofit

Patagonia will shed its current form as a California certified B-corporation to try on a new fit: the purpose-driven trust and nonprofit. The plan, characterized as the next step in Patagonia’s evolution as a responsible, earth-conscious business, is simple enough:

100% of the company’s voting stock transfers to the Patagonia Purpose Trust, created to protect the company’s values; and 100% of the nonvoting stock had been given to the Holdfast Collective, a nonprofit dedicated to fighting the environmental crisis and defending nature. The funding will come from Patagonia: Each year, the money we make after reinvesting in the business will be distributed as a dividend to help fight the crisis.⁶

The Holdfast Collective, the organization which will be the recipient of the dividends from Patagonia’s annual revenue – which the Chouinard family estimates will amount to $100 million each year⁷ – is a 501(c)(4) entity, a type of nonprofit also called a “social welfare organization.”

Because 501(c)(4) nonprofits are allowed to make political donations, much of the discussion about them in the past decade (particularly in the wake of the Supreme Court’s 2010 Citizens United v. FEC decision) has focused on “their role as the source of so-called dark money in electoral campaigns.”⁸ But devious political activity is not the 501(c)(4)’s only function. The Tax Code defines the 501(c)(4), or social welfare nonprofit as “[c]ivic leagues or organizations not organized for profit but operated exclusively for the promotion of social welfare,”⁹ and lists local volunteer fire companies as an example.¹⁰ A 501(c)(4) can make donations to political campaigns and entities so long as its political donations do not exceed 50% of its total donations.¹¹ Indeed, this ability – to lobby, to publicly support political candidates – is one of the key features that distinguishes this type of organization from other tax-exempt organizations such as the 501(c)(3).¹²

And yet, politically active organizations only make up approximately 10% of the 104,000 total 501(c)(4) organizations registered in the United States.¹³ Community service clubs (such as Lions and Rotary clubs), at 40%, account for a much higher portion.¹⁴

A 501(c)(4) nonprofit enjoys many, but not all, of the tax benefits available to other tax-exempt organizations per the federal Tax Code.¹⁵ One major tax benefit is that the organization itself is allowed a broad exemption from paying federal tax on its net income, subject to some exceptions.¹⁶ However, donors to a 501(c)(4) are not eligible for charitable contribution deductions from their federal income taxes, and the 501(c)(4) is liable for some state taxes from which the 501(c)(3) would be exempt.¹⁷

Significantly, the net earnings of a 501(c)(4) nonprofit must be “devoted exclusively to charitable, educational, or recreational purposes”¹⁸ and should not “inure[] to the benefit of any private shareholder or individual”¹⁹ other than to pay salaries and to reimburse the costs of operating a 501(c)(4).

B. What the Critics Say…

In discussing the news from Patagonia, two general categories of criticism arise: criticism against Chouinard’s decision specifically, and criticism against the 501(c)(4) form generally.

1. …About Patagonia & Chouinard

Critics of Chouinard’s decision generally characterize it as a devious move designed to avoid paying hundreds of millions of dollars in taxes.²⁰ In particular, the critics seem to believe that Chouinard has insidiously conned the government out of a $700 million capital gains tax, representing the approximate amount he would have had to pay had he chosen to sell the company on the market, rather than transfer all of its stock to the Patagonia Purpose Trust and the Holdfast Collective.²¹

The critics also claim that this move circumvents a 40% estate tax Chouinard’s heirs would have had to pay, had the Patagonia founder simply left them his shares in the company in a will (or alternatively, sold the company during his lifetime and willed the proceeds of the sale to his heirs).²² The estate and gift tax Chouinard would have had to pay in these scenarios is estimated at around $1 billion.²³ Another criticism is that Chouinard has avoided gift tax “that is normally payable whenever anybody makes gifts exceeding a lifetime limit of $12 million.”²⁴

2. …About 501(c)(4) Nonprofits

This is not the first time – not even the first time this year – that a 501(c)(4) has been used as a mechanism for a billionaire to “stash away” his wealth in lieu of selling assets and paying capital gains and estate taxes.²⁵ If this trend grows, the potential damage in lost tax revenue billionaires could inflict on the nation could be substantial and damage to the world could be even greater if such billionaires do not share Chouinard’s mission to “sav[e] this planet.”²⁶ These individuals can transfer assets (in this case, shares of the company Patagonia) whose value has appreciated into a tax-exempt entity which can then sell the asset without having to pay tax on the realized gain.

III. Response

Because donors to 501(c)(4) organizations are not eligible for charitable contribution deductions, after transferring his voting shares in Patagonia (and those of his wife and children) to the Patagonia Purpose Trust and the Holdfast Collective, Chouinard will owe a gift tax in the approximate amount of $17.5 million.²⁷

That’s it.

Obviously, $700 million in tax on the built-in gain in the Chouinards’ shares of Patagonia is more tax revenue than $17.5 million. Thus, mathematically speaking, what Chouinard will pay in taxes on the 501(c)(4) transfer is manifestly less than what he would have had to pay had he taken his company in a different direction.²⁸ However, there is no apparent reason to believe that there was an insidious motive behind Chouinard’s decision. He was not evidently motivated by a desire to illegally evade taxation, though the move does have the apparent side effect of legally avoiding taxation.

A. Chouinard Was Under No Obligation to Sell His Company

Critics who characterize Chouinard’s decision to transfer ownership as he did seem to anticipate that the trust and 501(c)(4) will soon sell the business. Thus, they interpret the transaction as an end-run around selling Patagonia on the open market to avoid paying a $700 capital gains tax. However, to date there has been no information about a looming sale. Significantly, Chouinard did not fail to perform some obligation to sell the company and reap the profit – that is, think-pieces about “skirting” taxes paint Chouinard in almost-criminal terms for merely the fact that he did not sell a company which he founded and owned. The implication seems to be that by virtue of owning a $3 billion outdoor apparel company, Chouinard was compelled (Morally? Legally? By the sheer overwhelming force of the capitalist regime? The critics do not say) one day to cash out.

However, the capital gains tax only comes due when an asset (such as the $3 billion company Patagonia) is sold – in tax terms, when a “realization event” has taken place. Yet Chouinard’s critics would find it difficult to point out any legal authority which imposes on business owners the obligation to sell their businesses. The Tax Code does not compel the owner of an asset to trigger a realization event and thereby force herself into tax liability.

B. Avoidance, Not Evasion

Tax evasion, the willful attempt to abstain from paying taxes which one owes under the Tax Code, is a felony.²⁹ Tax avoidance, the use of the tax system to reduce the amount of taxes one owes,³⁰ is not a crime, and it happens all the time. Had Chouinard sold Patagonia and then refused to pay the $700 million capital gains tax, his actions would constitute illegal tax evasion. Similarly, if the Tax Code imposed on business owners the obligation to sell their business, then shifting ownership of Patagonia to the trust and nonprofit would constitute illegal tax evasion.

But, given the point established in the previous sub-part – that Chouinard was under no legal obligation to sell Patagonia – and the fact that the Tax Code explicitly authorizes the existence of 501(c)(4) organizations, the Patagonia news can at worst be characterized as tax avoidance, not tax evasion. Chouinard used a perfectly legal mechanism to dispose of his wealth, and did so without neglecting any tax obligations.

However, based on Chouinard’s announcement, it would feel insincere to even suggest that Chouinard made this move out of a desire to avoid taxes. The situation might be different if, like Barre Seid, a billionaire who sold a business after donating it to a 501(c)(4) and gave its assets to a conservative political action group,³¹ Chouinard merely transferred Patagonia ownership stock in order for the 501(c)(4) to immediately sell it, thereby avoiding capital gains taxation. But to date that has not been the case. Instead, Chouinard’s 501(c)(4) (while it will avoid most taxes as a tax-exempt entity), has not expressed a plan to sell Patagonia, but instead seems intent on investing and reinvesting its earnings toward environmental causes.³²

C. Pretending that Billionaires Don’t Avoid Taxes Anyway

Critics who characterize the Patagonia shift as a means of avoiding estate taxes (rather than evading capital gains taxes) have a little more credibility to their point – unlike the fictional obligation to sell one’s company, the obligation to pay estate taxes upon one’s death is very real. Nevertheless, such criticisms lack a certain degree of realism. Estate planners every day make trusts for their clients which are explicitly designed to help the client avoid paying some or all of the estate taxes that would otherwise be owed on their estates. One hardly needs to be a billionaire to have a tax-avoiding trust built into one’s estate, and it would strain credulity to suggest that all or most billionaires don’t have some such mechanism in their estate plans. The Patagonia move, as it relates to estate taxes, is barely distinguishable from tax-avoiding trusts.

Moreover, given that donations to 501(c)(4) nonprofits are not tax-deductible, and Chouinard will pay an approximately $17.5 million gift tax on the transfer, he doesn’t exactly incur any tax benefits by this move. In addition, the move takes the stock largely out of the hands of his heirs, although they continue to control the trust and, presumably, the 501(c)(4) and will likely receive salaries and other perks for doing so.

IV. Conclusion

Billionaires’ use of the 501(c)(4) nonprofit may ultimately help or harm planet Earth. It may be used to insidiously avoid taxes or to legitimately contribute to important causes. But given that Chouinard chose, among multiple valid options, one which comes with tax consequences of its own, it cannot be said that this method was chosen for the purpose of evading taxation.The new method of operating Patagonia may have the effect of avoiding hundreds of millions in taxes, but there is no evidence to suggest that this was the motive behind the decision. The move is expected to generate around $100 million per year, which the Holdfast Collective is to apply to various environmental causes in compliance with rules established by Congress for the appropriate spending of funds by 501(c)(4) nonprofits. While the government may lose out on a single $700 million payday which it could have used for the military, public housing, education (etc.), after several years’ time, the option Chouinard chose should generate more money for the public good than a single transaction’s capital gains tax.

*Editor-in-Chief, University of Cincinnati Law Review, Vol. 91 (2022-23). My thanks to Professor Stephanie McMahon for her input and advice on this article.

Cover Photo by Patrick Hendry on Unsplash

Paul G. Rando

Paul's previous leadership roles include directing volunteer programs in international natural disaster recovery, (including managing a base of operations in Toa Baja, Puerto Rico, one in North Carolina, and leading teams to reconstruct 50 homes, 52 toilets, and 2 schools in Nepal), and leading a trail crew for a six month stint in the Vermont backcountry. Every leadership role is a humbling opportunity, and being chosen as the Editor-in-Chief for Volume 91 has been no exception. Paul's writing for the Law Review has focused on issues of the law of natural disaster recovery and the January 6 Capitol insurrection. After law school, he intends to work in natural disaster legal services, and aspires to open a disaster legal services clinic, to teach a course in Disaster Law, and to get his LLM degree. He currently works at Cummins Law. Read Paul's published Student Comment, Mitigating the Discretion Disaster: How Changes in the Law Can Help FEMA Effectuate Its Critical Mission, at the hyperlink below.

References

1
Yvon Chouinard, Earth is Now Our Only Shareholder, Patagonia (Sept. 14, 2022), https://www.patagonia.com/ownership/.
2
Id.
3
Id.
4
Devon Pendleton & Ben Steverman, Patagonia Billionaire Who Gave Up Company Skirts $700 Million Tax Hit, Bloomberg (Sept. 15, 2022), https://www.bloomberg.com/news/articles/2022-09-15/patagonia-billionaire-who-gave-up-company-skirts-700-million-tax-hit?leadSource=uverify%20wall
5
Dave Ross, Ross: Is Patagonia’s Sale to a Non-Profit a Shameless Exploitation of a Tax Loophole?, MyNorthwest.com (Sept. 20, 2022), https://mynorthwest.com/3644172/ross-patagonia-sale-truly-good-thing-or-shameless-lobbying-loophole/.
6
Chouinard, supra note 1.
7
Allyson Chiu, Patagonia Founder Gives Away Company: ‘Earth is Now Our Only Shareholder’, Wash. Po. (Sept. 14, 2022), https://www.washingtonpost.com/climate-solutions/2022/09/14/patagonia-yvon-chouinard-climate-change/.
8
Ellen P. Aprill, Examining the Landscape of § 501(c)(4) Social Welfare Organizations, 21 N.Y.U. J. Legis. & Pub. Pol’y 345 (2018) (citing Jane Meyer, Dark Money (2016)) (defining dark money as “money from groups that are able to influence elections without disclosing the source of their funds.”).
9
26 U.S.C. § 501(c)(4)(A).
10
Types of Organizations Exempt Under Section 501(c)(4), Internal Revenue Serv., https://www.irs.gov/charities-non-profits/other-non-profits/types-of-organizations-exempt-under-section-501c4 (last visited Sept. 23, 2022). Other examples include “A community association devoted to preserving the community’s traditions, architecture and appearance by representing it before the local legislature and administrative agencies in zoning, traffic and parking matters, . . . [and a]n organization that holds an annual festival of regional customs and traditions.” Social Welfare Organizations Examples, Internal Revenue Serv., https://www.irs.gov/charities-non-profits/other-non-profits/social-welfare-organizations-examples (last visited Sept. 23, 2022).
11
Aprill, supra note 8; see also Sean Sullivan, What is a 501(c)(4), Anyway?, Wash. Po. (May 13, 2013), https://www.washingtonpost.com/news/the-fix/wp/2013/05/13/what-is-a-501c4-anyway/.
12
Aprill, supra note 8.
13
Lloyd Hitoshi Mayer, A (Partial) Defense of § 501(c)(4)’s “Catchall” Nature, 21 N.Y.U. J. Legis. & Pub. Pol’y 439, 446 (2018); see also Internal Revenue Service Data Book, 2021, Table 14, at 30.
14
Id.
15
Id. at 468-69.
16
Id.
17
Id. (citing inter alia, I.R.C. §§ 170(c), 2055(a)).
18
26 U.S.C. § 501(c)(4)(A).
19
26 U.S.C. § 501(c)(4)(B).
20
Pendleton & Steverman, supra note 4; Ross, supra note 5.
21
Pendleton & Steverman, supra note 4.
22
Id.; Ross, supra note 5; see also Andrew Ross Sorkin et al., Philanthropy, the Billionaires’ Way, N.Y. Times (Sept. 16, 2022), https://www.nytimes.com/2022/09/16/business/dealbook/philanthropy-patagonia-billionaires-way-taxes.html (“Such donations can minimize the tax hit that billionaires would otherwise pay on huge gifts and inheritances.”).
23
Sorkin et al., supra note 22.
24
Felix Salmon, The Ultimate Billionaire Tax Dodge, Axios (Sept. 17, 2022), https://www.axios.com/2022/09/17/the-ultimate-billionaire-tax-dodge.
25
Sorkin et al., supra note 22.
26
Chouinard, supra note 1. Consider ultra-billionaires like Amazon’s Jeff Bezos, Meta’s Mark Zuckerberg, and Tesla’s Elon Musk. It would not be entirely outlandish to picture any one of them shifting their wealth to a 501(c)(4) that supported fossil fuel industries, fought against conservation of public lands, or lobbied against the development of environmentally friendly technologies.
27
Pendleton & Steverman, supra note 4; Sorkin et al., supra note 22.
28
If he had chosen, say, to “go public” instead of “going purpose.”
29
26 U.S.C. § 7201.
30
Julie Kagan, Tax Avoidance, Investopedia (Mar. 20, 2022), https://www.investopedia.com/terms/t/tax_avoidance.asp.
31
Sorkin et al., supra note 22.
32
Patagonia’s Next Chapter: Earth is Now Our Only Shareholder, Patagonia (Sept. 14, 2022), https://www.patagoniaworks.com/press/2022/9/14/patagonias-next-chapter-earth-is-now-our-only-shareholder.