Yvon Chouinard’s decision to gift his $3 billion Patagonia apparel empire to a charitable trust last year shined the spotlight on non-cash charitable gifts. But your clients don’t need to be billionaires to realize the philanthropic and financial benefits of giving non-cash assets such as S corporation (S corp) shares to their favorite causes.
Two Advantages
There are two primary advantages of making non-cash philanthropic gifts:
1. Most high-net-worth (HNW) families have the bulk of their wealth in non-cash assets. These assets include marketable securities, real estate and interests in private businesses. When the families want to make significant charitable gifts, they’ll often need to look beyond their cash.
2. Giving non-cash assets often provides better tax benefits than giving cash. Appreciated assets such as marketable securities, real estate and private business interests often provide double, or even triple, the tax benefits of cash gifts.
How so? If a client gifts a publicly traded stock that has substantially appreciated in value (and has been held for more than a year), they can give the stock to charity and receive a double tax benefit. First, they receive a charitable deduction for the value of the stock and they avoid capital gain tax. Even better, the designated charity avoids capital gains tax when it eventually sells the stock. So, by using non-cash assets, families can give significantly more to their favorite charities than by simply writing checks.
Underused Strategy
Why are gifts of S corp stock so often overlooked? According to my friend Michael King, charitable gift and estate-planning attorney with the National Christian Foundation, this strategy is underused because many business owners (and their advisors) aren’t aware of its advantages. And even if they are, King said they’re often dissuaded because of the complexity associated with such gifts. But a specialist may be able to help them.
Two Scenarios
Here are two scenarios when it can be especially advantageous for your business owner clients to gift S corp stock:
1. Decision to sell. When business owners have decided to sell their business, and therefore, are facing a significant tax liability—likely the largest taxable event of their life. By making a charitable gift of stock prior to a sale, the owner secures a charitable deduction for the value of the gifted interest and personally avoids capital gains tax on the gifted interest. If the interest is properly structured, when the charity sells its interest, it will have a much lower tax liability compared with what the owner would have paid personally—often reducing the associated tax liability by 60% or more.
2. Plan to sell near term. When owners have plans to sell near term but want to use their business as an engine for generosity. Typically, they'll target the maximum they can deduct on an annual basis.
If your client gives an asset other than cash, the maximum they can deduct each year is 30% of their adjusted gross income (AGI). As a result, many families will carve off small ownership pieces of their business as a gift that targets 30% of their AGI. For many business owners, a gift amounting to 2% to 4% of the fair market value of their business will enable them to maximize the allowable 30% of AGI deduction. In addition to giving cash as they’ve already been doing, some families will take all, or a portion, of the tax savings generated from the charitable deduction of the business interest gift and then make an additional cash gift. It’s not unusual for families to maximize their total charitable deductions—50% of their AGI—using this strategy.
The charity that receives the business interest gift will simply hold its ownership interest until a liquidity event occurs. In the meantime, the charity will receive a pro-rata portion of any taxable income and distributions made by the business—if the business is a flow-through entity such as an S corp, limited liability company (LLC) or partnership—and any dividend distributions made by a C corporation (C corp).
Real-World Example
A successful business owner we work with is very charitably inclined and doesn’t need all the cash that her company throws off. Because she’s not planning to sell the company anytime soon, she decided to give S corp stock worth 20% of the company to her favorite charity. In addition to the emotional satisfaction from her gift, she receives a charitable deduction up to 30% of her AGI for the contribution of non-cash assets held more than one year—and her excess contributions may be carried forward for up to five additional years.
Most charitable gifts cause no tax problems for charities. However, S corp stock is an exception to that general rule. My client’s large gift creates unrelated business income (UBI) for the charity. Even though there’s taxable income, if we’ve selected the right charity and structured the gift properly, it’s possible to reduce the effective tax rate to slightly less than 15%, rather than the 37% ordinary income rate. And, our client never receives this income, so she doesn’t pay tax personally.
This strategy requires some number crunching and comprehensive analysis, but the benefits to our very charitable clients are significant.
“This ‘engine for generosity’ strategy effectively captures a triple tax benefit,” explained King. “First, the business owner receives an immediate charitable income tax deduction; second, the charity pays a reduced effective tax rate on the charity’s share of annual operating income, and third, upon an eventual sale of the gifted interest, the charity pays a reduced capital gain tax (and in some cases avoids capital gains tax completely),” King added.
Just remember to consider the type of business entity being considered for a charitable gift of interest in a privately held business. For example, UBI applies to S corps, LLCs and partnerships, but it doesn’t apply to C corps (though C corps are subject to a corporate level tax even for stock owned by charity). If a charity plans to hold an interest in certain private businesses longer than five years, an excise tax referred to as “excess business holdings” may come into play, requiring proper planning to avoid the imposition of such tax. However, the benefits of gifting S corp stock rather than cash are significant for both donor and beneficiary.
Despite the headwinds faced by today’s economy and financial markets, we haven’t seen a significant reduction in charitable giving. I expect that gifts of marketable securities will be down from last year, but remember, many of your clients have highly appreciated marketable securities available for giving. Even those who lost 20% of the value of their marketable securities portfolios may have stocks with a very low cost basis that continue to provide leveraged giving opportunities over cash.
Randy A. Fox, CFP, AEP is the founder of Two Hawks Consulting LLC. He is a nationally known wealth strategist, philanthropic estate planner, educator and speaker.