CGNA: Chapter 3 - S Corporations | Quick Take-Aways

CGNA: Chapter 3 - S Corporations | Quick Take-Aways

Article posted in General on 30 November 2017| comments
audience: National Publication, Bryan K. Clontz, CFP®, CLU, ChFC, CAP, AEP | last updated: 4 December 2017


Gifts of S Corp stock are among the trickiest. We begin the steps of learning the do's and don'ts.

This article is an excerpt from Charitable Gifts of Noncash Assets, a comprehensive guide to illiquid giving by Bryan Clontz, ed. Ryan Raffin. Published by the American College of Financial Services for the Chartered Advisor in Philanthropy Program (CAP), with generous funding from Leon L. Levy. For a free digital copy, click here, and to order a bound copy from Amazon, click here.

Below are quick take-aways on S corporation gifts. S corporation topics are based on Christopher Hoyt’s “Charitable Gifts by S Corporations and Their Shareholders: Two Worlds of Law Collide,” and “Charitable Gifts by S Corporations: Opportunities and Challenges.” For quick take-aways on S corporation gifts, see S Corporation Quick Take-Aways. For a review based on the articles, see S Corporations Intermediate. For an in-depth examination adapted and excerpted from the articles, see S Corporations Advanced. For further details, see S Corporations Additional Resources.

Generally, the best asset to donate is appreciated capital gain property, but Subchapter S corporation stock is a potential exception. A charity pays unrelated busi- ness income tax (UBIT) on its gain from selling S corporation stock. Thus the charity has to pay income tax on precontribution gain, post-contribution gain, and any allocated income during the holding period. One solution can be for the S corporation stock to be donated to a public charity-sponsored donor-advised fund in trust form. Another option is for the business itself to donate assets.

Advantages of donations of S corporation shares include:

  • The stock of an S corporation might be valuable, based on the underlying corporation assets.
  • A donation to a public charity in trust form can mitigate up to 50 percent of the UBIT.
  • Donating the assets from the corporation will allow the charitable deduction to flow through proportionally to all shareholders.
  • Donors may contribute S corporation stock as an outright gift or for a charitable gift annuity.
  • There are more S corporations than C corporations and LLCs combined.

Disadvantages of donating S corporation shares include:

  • The donor's income tax deduction may be less than the stock’s appraised value if there are so-called “hot assets” or other ordinary income elements.
  • The charity must pay tax on its share of S corporation income for every day it owns the stock, and on gain from the sale of the stock after taking the donor’s carryover tax basis.
  • If S corporation stock is donated to a charitable remainder trust, 100 percent of the UBIT is taxable making it a very inefficient gift.

Wrinkles in the process to consider include:

  • It may be more efficient for the S corporation to donate assets, however a large shareholder base may make this unwieldy, since each shareholder would have to agree on the charity. A solution can be donor-advised funds created for each shareholder proportionally.
  • It is important that the Shareholders Agreement has an equalization clause so the charity receives distributions to pay the unrelated business tax.

Discovery Questions

Donor Questions
  1. What is the donor trying to accomplish with the gift?
  2. What is the value of the stock and how was that determined (e.g., appraisal, 409A valuation, recent transactions)?
  3. What is the total percentage of stock that the donor owns when combined with all related entities (probing if the excess business holding issue will apply)?
  4. Legally, who or what owns the shares?
Advisor Questions
  1. What is the current tax basis per share?
  2. Do the governing documents allow charitable transfers, and if so, what is the process?
  3. What is the likely exit plan for the charity (e.g., will sale be for cash, note, stock, or some combination)?
  4. Does the advisor have an estimate of what a qualified appraisal will cost (this expense can vary greatly and can be an impediment to smaller donations)?
  5. Are there any “hot assets” which will trigger the ordinary income reduction rules on the deduction?
  6. Does the donor want to use a public charity sponsoring a donor-advised fund to mitigate UBTI?
  7. What is the expected after-tax cash flow from the stock (cash distributions less UBIT paid)?
Charity Questions
  1. Is the effort worth the expected benefits (i.e., is the juice worth the squeeze)?
  2. Has the screening and due diligence process identified any potential problems and can the risks be mitigated?
  3. Is there the necessary expertise to accept gifts of private stock in a timely way?
  4. Should indirect gift acceptance be considered, like using external third party foundations or supporting organizations to receive the asset?
  5. Is there a clear liquidation plan to maximize the sales proceeds as soon as possible?
  6. Is the charity comfortable making quarterly UBIT estimated tax payments and then calculating and filing the 990-T return?

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