Gift of a Business Interest
A gift of an appreciated business interest held for more than one year may be well suited to a successful business owner reaching retirement who wants to meaningfully support our work while obtaining a double tax benefit.
A gift of a business interest works like this:
- Working with counsel, the donor determines if any restrictions (in the entity documents or state statutes, regulations, or ordinances) would limit how ownership of the business can be transferred.
- The donor discusses the desired gift with us to ensure we can accept it. Some gifts may be more difficult than others (for example, a business interest that results in unrelated business taxable income can pose a significant obstacle).
- The donor conducts any relevant review that might be required. For example:
- Conduct a Phase I or Phase II environmental report on business-owned real property
- Ensure that the corporation’s assets, both real and tangible, are free of liens with issues
- Ensure there are no clouds on the title to real property
- Ensure there is no pending litigation (or known potential claims) against the corporation
- The donor obtains a qualified appraisal of the business interest.
- The donor transfers the entire business interest to the UMass Foundation.
- The gift qualifies for a charitable income tax deduction for the fair market value of the business interest at the time of the gift (assuming the donor itemizes).
- The donor bypasses any capital gains tax that would have been due on a sale of the business interest. This can be a highly significant benefit, assuming the business interest has a low cost basis and substantial appreciation.
Consider that a gift of an interest in a C corporation is the most straightforward. S corporations have more to consider, and interests in partnerships or LLCs require consideration of a number of practical issues.
Caution
A donor should use extreme caution if they plan to donate a business interest while negotiating a sale of the business. If negotiations have proceeded to a point where the IRS considers it a prearranged sale, they may be required to pay capital gains tax when the UMass Foundation sells the interest.
Donating a partial interest
In most cases, the donor must irrevocably donate the entire interest to qualify for a deduction. However, if the donor wishes to make a partial interest gift, there are three exceptions that will still qualify for a deduction:
- A contribution of a remainder interest in a personal residence or farm
- A contribution of an undivided portion of your entire interest
- A qualified conservation contribution
Evaluate the fit.
A gift of a business interest may be a particularly good option for clients who are considering selling a business if they want to:
- Meet significant philanthropic goals
- Qualify for a double tax benefit—a charitable income tax deduction (if they itemize) and no capital gains tax on the appreciated value of the business interest
See how it works.
Claire owns a successful business with privately held stock. Her cost basis is $0, and the stock is currently valued at $27 million (based on a qualified appraisal). Claire decides to use $9 million of stock to support the UMass Foundation. She could sell the shares (subject to capital gains tax and possibly net investment income tax) and donate the proceeds. However, her advisor recommends considering a direct donation of the stock, which would mean bypassing taxes and making a more substantial gift.
Claire knows several investors who are greatly interested in the stock, but she has not begun any substantive discussions about a sale, nor has she entered into any type of agreement to sell the stock. Claire works with us, her legal counsel, and her advisor to directly donate the stock.
Sale then Donation
- Value of Stock $9,000,000
- Capital Gains Tax (20%) $1,800,000
- Potential Net Investment Income Tax $342,000
- Actual Gift Amount $6,858,000
Direct Donation to Charity
- Value of Stock $9,000,000
- Capital Gains Tax (20%) $0
- Potential Net Investment Income Tax $0
- Actual Gift Amount $9,000,000
By donating the stock directly to us, Claire increased her gift by $2,142,000. Following the donation, the UMass Foundation initiates discussions with the interested investors to arrange a sale of the stock.
Consider the timing.
A gift of a business interest is complicated and requires many steps and the involvement of many different professionals. If your client wants to ensure that the tax benefits fall within a particular year, they should start the process as early as possible.
The UMass Foundation can help.
Start with us. An initial productive discussion about your client’s business interest and goals is imperative to the ultimate success of the gift.