Sales of family businesses or privately held companies can create tax planning and philanthropic opportunities. Donating a portion of the shares to a charity or donor-advised fund account before the sale can help to reduce the tax burden and enable more to be given to charity.
You must obtain a qualified appraisal of the shares to substantiate the charitable deduction claimed. Appraisals must be obtained no earlier than 60 days before the date of donation and no later than the date of the donor’s tax return (including extensions) for the year of the gift. Appraisals depend on the facts and circumstances at the time of contribution and may be discounted for lack of marketability or the presence of a minority interest. Indebted interests may trigger negative tax consequences for donors and recipients.
The company’s shareholder agreements and other governing documents must be reviewed to understand transfer restrictions, timing, and process to complete the charitable transfer. The terms of the sale should still be under negotiation. The documentation must not have proceeded to the point at which the IRS would consider it a prearranged sale. That could result in the donor bearing the tax liability for any gain on the sale. If the sale is not completed, the charity or donor-advised fund account controls the contributed shares.
After a gift of S-Corp stock is made but before the sale is completed, the charity or donor-advised fund account will generally be subject to unrelated business income tax on its gain from the sale and any income generated during its ownership. The charity or donor-advised fund provider will generally use the proceeds of the sale to pay these taxes, and may escrow a portion of the proceeds in a separate account for three years to match the IRS “look back” period, during which the IRS can challenge the cost basis of the shares and the taxes paid.
Contributions of privately held stock to a charity or donor-advised fund account are generally deductible at fair market value on the date of contribution, whereas such contributions to a private foundation are generally deductible at the lower of cost basis or market value.
Limited Partnerships Or Limited Liability Corporations (LLCs)
Limited partnerships and limited liability corporations generally have the same deductibility rules, holding-period considerations, and adjusted-gross-income limits as privately held stock. Illiquidity and minority discounts may apply to the appraisal.
Unless the interest can be sold back to the entity, a sale may be difficult to arrange. If the interest can be sold, the charity or donor-advised fund provider will negotiate the sale price and control the sale using an experienced intermediary. Partnerships and multi-member LLCs are taxed as flow-through entities; thus, if they engage in an active trade or business or have acquired assets with debt, the income earned by the charity or donor-advised fund account may be subject to unrelated business income tax. The complexities of flow through entities make it important to consult a tax advisor prior to donating an interest in one.
As with publicly traded partnerships, gifts of indebted interests may trigger negative tax consequences for donors and recipients, and the charitable deduction must be reduced by the amount of ordinary income that would have been realized if the interest had been sold at fair market value on the date contributed.
Private Equity, Venture And Hedge Fund Investments