Closely-Held, Non-Publicly Traded Stock: Using a Complex Asset for Better GivingSubmitted by American Endowment Foundation on April 12th, 2021
By Stacey Delich-Gould, Senior Vice President, Senior Trust and Estate Specialist, and Greg Singer, Investment Director, Capital Group Private Client Services - New York City, Guest Columnists
A gift of appreciated property to a charity may allow a donor to take an income tax deduction for the full fair-market value (FMV) of the property on the date of the donation, without having to recognize the appreciation as income. However, when a donor uses closely-held, non-publicly-traded stock (CHNPTS) to make such a gift, complex issues arise.
A charitable gift of long-term (held for one year or more), publicly-traded stock is generally a straightforward transaction: the donor can usually take an income-tax deduction for the FMV of the donated stock as of the date of contribution without recognizing any gain. However, many business owners have a significant portion of their wealth invested in their business in the form of CHNPTS, which can present some challenges.
Most significantly, a donor who contributes long-term CHNPTS to a private, non-operating foundation is typically limited to an income-tax deduction equal to the basis, not the FMV, of the CHNPTS contributed, such that the corresponding deduction for any appreciation is lost. In addition, the deduction for a gift of such stock to a non-operating foundation is ordinarily limited to 20% of the donor’s adjusted gross income (AGI).
By contrast, a gift of long-term CHNPTS made to a public charity, including a donor advised fund (DAF) or operating foundation, can result in a full FMV deduction for the donor, and such gifts generally are deductible up to 30% of the donor’s AGI. To achieve this outcome, the gift must be structured carefully and certain issues, not applicable to gifts of publicly-traded stock, must be considered.
Structuring the Transaction
A key concern for both the business (in which the CHNPTS is held) and the charitable donee is ownership. The business often does not want an outsider such as a charity as an owner of its closely-held stock, and the charitable donee usually has no interest in owning an illiquid asset, especially if it represents an interest in an operating business. In addition, if the charitable donee is a DAF, it must ensure that its receipt of the donation does not implicate the “excess business holdings” rules (triggered when a DAF owns more than 2% of a business).
Thus, when a charitable gift of CHNPTS is made, it is often in the interests of all parties for the CHNPTS to be redeemed as quickly as possible. (A charitable donation of CHNPTS can also be made in anticipation of a liquidation event, so long as the donation is made before any formal decision to liquidate the business.)
But in order to preserve the income tax advantages to the donor associated with the donation, there cannot be any prearranged agreement between the donor and the charity. In other words, there cannot be any pre-existing obligation on the part of the charity that it will offer the CHNPTS for sale back to the business or that the business will buy back the CHNPTS from the charity, as a condition of the donor making the gift to the charity.
Under the “assignment of income” doctrine, if such a prearrangement or obligation is found by the Internal Revenue Service (IRS) to exist, the charitable contribution made by the donor is reclassified as follows:
- it is deemed a sale of the CHNPTS by the donor;
- any gain on the sale must be recognized by the donor and,
- the donor is then deemed to have made a gift to the charitable donee of the proceeds from the sale.
A deemed sale means that the donor has recognized the gain in the asset and will be taxed accordingly, defeating the goal of making a charitable gift that also minimizes a donor’s capital gains tax and maximizes a donor’s charitable deduction.
Valuation and Substantiation Considerations
Because there is no readily accessible market for CHNPTS, an appraisal (by a qualified appraiser) is often required. The IRS currently requires an appraisal for charitable contributions of CHNPTS valued in excess of $10,000, and failure to obtain such an appraisal can result in the disallowance of any deduction. In addition, charitable contributions of CHNPTS valued in excess of $500,000 must be filed with the IRS.
A gift of CHNPTS by a donor to a charity is a complex transaction that gives rise to many legal and tax issues. Donors should consult with their attorneys, accountants and other relevant advisors prior to considering such a donation to ensure that it is structured properly to preserve the desired income tax benefits and to effectuate the donor’s charitable intent.
At American Endowment Foundation, we look forward to discussing how to turn complex assets into better charitable giving. Contact us or call at 1-888-660-4508 to learn more.