Two Key Pitfalls To Avoid When Gifting Closely-Held Business Interests - Part OneSubmitted by American Endowment Foundation on September 9th, 2019
By Laura Malone
Part One of a Two-Part Series
According to data from the 2016 Annual Survey of Entrepreneurs (ASE), published in 2018, just over 50% of the 5.2M respondents were over 55 years of age1. In other data from the same survey, over 31% of all owners do not have any kind of exit strategy planned. Even worse, over 14% just plan to walk away from the business2. Sadly, only about 5.6% have sought business advice about succession planning and/or exit strategy.
In a study conducted by Artemis Strategy Group, an independent research firm, it is noted that entrepreneurs give more time and money than non-entrepreneurs. The average household donation of an entrepreneur is more than four times that of a non-entrepreneur, while the median household donation is 50 percent higher.
Entrepreneurs also spend more hours per month volunteering3. This creates a great opportunity for advisors to not only talk to their business owner clients about better planning for leaving their businesses, but also opens the door to discussing the personal and tax benefits of incorporating charitable giving into that strategy.
Charitable planning and donor advised funds are an overlooked tool in helping a business owner when they are selling their business. A donor advised fund (DAF) cannot only be an excellent source of tax savings and wealth preservation (selling some or all the business in a DAF can save the 20% tax on capital gains) but allows the owner to build something of significance beyond their business. However, these opportunities are not without potential pitfalls. Two of the biggest pitfalls that can destroy the tax benefits that make this so attractive are:
- Failure to stay ahead of a legally binding commitment to sell the company
- Failure to procure a qualified appraisal by a qualified appraiser
Here is what you need to know to keep your clients out of the IRS crosshairs.
What is a legally binding commitment to sell? Why is it important?
The IRS has set precedent through a variety of tax court cases where charitable gifts have been prevented or the tax benefits overturned because the donor had proceeded too far in selling the property before contributing it to charity. In these instances, the donor no longer gets to enjoy the benefit of avoiding that 20% capital gains tax exposure. Instead, the donor must recognize the gain on the sale and treat the gift of stock no different than a gift of cash.
The most obvious “legally binding commitment” is a signed purchase agreement. If this has already happened, the process has gone too far, and it is not advised that the donor attempt to make a gift of stock. However, it is also important that the donor pay close attention to the verbiage in any Letter of Intent (LOI) or other agreement that may be signed in advance of a purchase agreement. If those agreements expressly state it was the intention of the parties that the document be legally binding, the donor may have also gone too far. It is strongly advised that if any gift being contemplated is in the Letter of Intent stage, or similar document, that those documents be reviewed by BOTH the donor’s tax advisor and legal counsel to ensure that the documents may not be construed by the IRS as a “legally binding commitment”.
At American Endowment Foundation, we look forward to taking the complexity out of complex assets. Please contact us or call at 1-888-966-8170 to discuss your specific circumstances.