What to Consider to make a Business Change an Opportunity for Giving
Suppose you have a low basis concentrated position held more than a year in a company approaching a transaction. If you would like to minimize tax drag and are charitably inclined, you will want to avoid taxes on some of your unrealized gain by gifting shares, rather than proceeds, to charity. The charity will then effect or participate in the sale. The concept is simple but there are plenty of details to consider.
Timing the Gift and Sale of Shares
Typically, you want the same timing for both the gift to charity and the sale of the stock to maximize both your deduction value and any sale price. In practice, however, synchronizing the two may be challenging and could sometimes be disadvantageous.
Perhaps your business is headed toward an initial public offering (IPO) or an acquisition for stock by a public company. One option is to make share gifts to charity after the deal is complete. You will have daily price visibility, but will likely face other constraints:
- Shares may be subject to a sale lockup period and to transfer restrictions, some of which may extend indefinitely due to your position or shareholder size.
- The public share price may be volatile or trading volume may be low. In these instances, minimizing price change exposure between the gift date and subsequent sale date requires careful planning.
What if your company’s IPO will allow investor sales and you would rather not take the price risk that comes with waiting out the lockup period? The capitalization table is usually frozen before the road show and pricing meeting. If you want a charity to be eligible to sell at the IPO, you face making a gift before the price is set and even before the final decision to go public is made.
An acquisition for cash will set the sale timing for you. But the gift to a charitable entity needs to occur early enough, before shareholder and other approvals have been obtained, to avoid the risk of treatment as a deemed sale prior to the gift. This means taking some risk that the deal could fall through after you have already made the gift.
How to Time When the Charity Gets the Money
At Lake Street, many of our families use a charitable conduit entity, such as a donor advised fund or a private foundation. With either, you can optimize the timing of your deduction and sale but choose a later date for the ultimate charity to receive cash. Each entity type has advantages and disadvantages with respect to control, privacy, costs, flexibility, taxation, administrative ease, and other items. Working with each family and their advisory team, we help navigate the pros and cons. Sometimes it even makes sense to have both.
One key distinction between donor advised funds and private foundations involves the value applied to the charitable deduction. Donor advised funds are public charities and the charitable deduction for gifts to them is set at fair market value. The charitable deduction for gifts of non-publicly traded stock to private foundations is limited to basis, generally eliminating private foundations from consideration unless the stock is public and not restricted.
What if you want a lifetime cash flow stream from the proceeds? A charitable remainder trust (CRT) may be the perfect option. After you, or you and your spouse, have passed, trust assets can go to charity, including a foundation or donor advised fund. While the gain on the sale and subsequent investment activity is taxable, taxes can be deferred over many years.
Additional Tax Considerations
The above is just a brief flyover on charitable timing. There are many more details that may be relevant, a few of which are touched on below.
- Charitable deductions are limited to 20% of your income for gifts of stock to private foundations, and 30% for public charities. Unused deductions may be carried forward, but only for 5 years. Planning can get tricky regarding how carryforwards work. Generally, current year gifts are deducted first, after which carryforwards are applied under a first-in-first-out (FIFO) method. Careful planning is required to ensure, if possible without taking unwanted price risk, that the pattern of income and deductions over time allows no carryforward to expire unused. Income includes gains realized from any sales of the concentrated position.
- If a stock gift to a public charity is made while the stock is non-publicly traded, its value must be quantified by a qualified appraisal and your tax filing for that year requires a signed Form 8283. You will want an appraiser who can deliver as high a value as can be well supported and successfully defended.
- Consider from which family shareholder the stock gift should come. Often, shares are held in, or can be moved to, family entities with different income tax treatments. One example is irrevocable trusts that allow charitable beneficiaries. Perhaps trust beneficiaries could make better use of a deduction, in which case a distribution to the beneficiary followed by a gift to charity could make sense. If it is a grantor trust for income tax purposes, the trust could make a gift directly and the deductions, plus any gain realized from trust sales, would land on the grantor’s tax returns.
From this list of items, it is clear that your advisory team, including your tax and estate advisors, should be involved early and often.