Best Practices for Gifts of Stock
October 24, 2019 (by Joe Hancock, Vice President & General Counsel) - Probably the most common noncash gifts involve securities, either publicly traded or closely held. Publicly traded stocks are fairly easy to handle from the charity’s perspective and relatively easy for the donor to transfer. The valuation of these stocks is well established and, therefore, makes them attractive gift options. However, gift planners should also be aware of the general tax benefits and implications related to all gifts of stock, and the valuation considerations and other issues related to gifts of closely held securities, to ensure that donors are able to provide the greatest benefit to the organizations they wish to support. This article will highlight important issues relating to gifts of both publicly traded and closely held securities.
Gift planners should be aware of tax benefits and implications.
Taxation Issues. As the taxation issues for a gift of stock are examined, several pieces of information will be helpful as the gift planner outlines the gift for the donor. The length of time the donor has held the security will determine whether the security qualifies for long-term capital gain treatment.
How the donor acquired the stock determines the donor’s basis in the security. If the stock is acquired by reason of a testamentary gift, the stock receives a step-up in basis equal to the fair market value (FMV) of the stock on the date of the testator’s death or, if elected, the alternate valuation date. Internal Revenue Code (IRC) §2032. If the stock was purchased by the donor, the basis will be the amount the donor paid for the stock at the time of acquisition. However, when the donor transfers stock with a dividend reinvestment program, the basis becomes less certain. If the stock is acquired by gift, a carry-over basis is attached, and the donor’s basis is the same as that of the person from whom the gift was received. The stock’s basis determines whether the stock has a gain or loss. This knowledge helps the gift planner counsel the donor regarding the tax consequences of the gift and the advisability of using the stock as a gift asset.
If the donated stock has been held by the donor for more than one year, the gift qualifies for long-term capital gain treatment, and the gift is deductible at FMV. IRC §170(e). The required holding period of one year begins on the day after the trade date that the stock was acquired by the donor and ends on and includes the date of gift. Rev. Rul. 70-598, 1970-2 CB 168.
For gifts to a public charity, the charitable income tax deduction for a contribution of appreciated stock may be used to offset up to 30 percent of the donor’s adjusted gross income in the year of the gift. The donor may carry over any excess deduction for up to five additional years. IRC §170(e); IRC §170(b)(1)(C)(i); Reg. §1.170A-8(d)(1); and IRC §170(b)(1)(C)(ii). A donor may choose to apply a 50 percent limitation (rather than a 30 percent limitation), if an election is made by the donor to reduce the value of the gift by the amount of the capital gain. IRC §170(b)(1)(C)(iii); IRC
§170(e)(1)(B); and Reg. §1.170A-8(d)(2). For gifts to private nonoperating foundations, the deduction is generally the lower of cost basis or FMV and is limited to 20 percent of the donor’s adjusted gross income. IRC §170(e)(1)(B)(ii) and IRC §170(b)(1)(D). If the donor is a corporation, the deduction is limited to 10 percent of the corporation’s taxable income, with the same five-year carryover. IRC §170(b)(2) and IRC §170(d)(2).
For appreciated securities that have been held by the donor for less than one year, different rules apply. Such securities, if sold by the donor at FMV rather than contributing them to charity, would generate gain that is not long-term capital gain. Reg. §1.170A-4(b)(1). The charitable deduction for such short-term capital gain property must be reduced by the amount of gain that would not have been long-term capital gain if the contributed securities had been sold by the donor at FMV. IRC §170(e)(1)(A); and Reg. §1.170A-4(a)(1). However, the deduction may be claimed up to 50 percent of the donor’s adjusted gross income in the year of the gift. IRC §170(b)(1) (A). And, as mentioned above, the donor
is allowed five years after the year of the gift to carry over any unused portion of the deduction, subject to the same 50 percent limitation. IRC §170(d)(1); and Reg. §1.170A-10.
Valuation Considerations. The valuation of publicly traded securities is very clear. The gift amount is the FMV of the security on the date of the gift — the date on which the charity takes possession of the stock. FMV is defined as the price at which the property would change hands between a willing buyer and a willing seller, neither being under any compulsion to buy or sell and both having reasonable knowledge of relevant facts. Reg. §1.170A-1(c)(2). The Internal Revenue Service (IRS) has further asserted that the most probative evidence of FMV is the price at which similar quantities of property are sold in arm’s length transactions. Rev. Rul. 80-69, 1980-1 CB 55. Therefore, FMV is to be determined in the market in which the item is most commonly sold to the public. Id. For publicly traded stock, the stock market provides the forum for determining the value. The deductible value is the average of the highest and lowest quoted selling prices on the valuation date. Reg. §§25.2031-2(b)(1), 20.2031-2(b)(1).
For publicly traded securities with no sales on the valuation date but sales within a reasonable period before and after the valuation date, the value is the weighted average of the means between the highest and lowest sales on the nearest dates before and after the valuation date. Reg. §§25.2512-2 (b)(1), 20.2031-2(b)(1).
If the securities are listed on more than one exchange, the records of the exchange where the securities are principally traded are those used to determine FMV on the valuation date. Reg. §§25.2512-2 (b)(1), 20.2031-2(b)(1).
For publicly traded securities, the tax rules are clear as to valuation, but charities must provide the correct substantiation to the donor. Most charities have a policy to sell gifted securities immediately. Typically, the security will be sold the day the gift is made or shortly thereafter. The
charity must be diligent in its record-keeping. The gift of stock must be recorded and not credited to the account as cash from the sale of the security. Charities must pay attention to the written substantiation and clearly define the gift as one of stock. If the charity is going to credit
the donor with a dollar amount for gift recognition purposes, that amount should be reported separately.
The charity must be diligent in its record keeping.
As noted above, the value of publicly traded securities is easily determined by the stock market. However, when a donor makes a gift of closely held securities and claims a charitable deduction in excess of $5,000, a qualified appraisal must be obtained in order to determine the value and claim the deduction. Reg. §1.170A-13(c)(1)(i). A fully completed appraisal summary must be attached to the return on which the deduction is first claimed. Reg. §1.170A-13(c)(2)(i)(a)-(c).
Gifts of closely held securities. For a donor or charity that is contemplating a gift of closely held securities (or a partnership interest in a business),
more often than not the provisions of a buy-sell agreement or business continuation agreement will have to be addressed. Such an agreement provides for the transfer of an ownership interest in the closely held corporation upon the occurrence of certain contemplated events. Such events typically include the owner’s death, disability, insolvency, retirement, or other withdrawal from the business at an earlier time than expected. Several versions of this type of agreement are commonly encountered, including:
- A corporate stock redemption agreement entered into between the business itself and the individual owners whereby the business agrees to acquire each owner’s interest upon the occurrence of certain stated events;
- A cross-purchase agreement entered into among the individual owners whereby the remaining owners would acquire the withdrawing owner’s interest upon the occurrence of certain stated events;
- A “third party” business buyout agreement entered into between the individual owners and a specified individual (key person, family member, third party, etc.) whereby the withdrawing owner agrees to sell his interest to the specified individual; or
- A combination of the foregoing.
The primary reason that most buy-sell agreements and business continuation agreements are put in place is to prevent all or any part of the business from falling into the hands of outsiders. Accordingly, many of these agreements are drafted in a manner that provides the most protection possible for the business entity and its existing owners, by limiting the possibility for an ownership interest to pass to any party not already associated with the business. It is rarely contemplated that a charitable gift of the closely held business interest will occur. As a result, you are unlikely to ever see a provision in one of these agreements that provides for a charitable contribution of an ownership
interest in the business.
What you will see is a provision or multiple provisions that place restrictions on the manner in which the transfer of an existing ownership interest may be accomplished. For example, some agreements provide that an existing ownership interest may not be conveyed to any outside party without the prior approval of the board of directors or a majority of the remaining partners. In this type of situation, it is very possible to complete a gift transaction by following the procedural requirements of the buy-sell agreement or business continuation agreement to
obtain the requisite approval.
More commonly, a buy-sell agreement or business continuation agreement will grant the remaining individual owners or the business entity itself, or both, a right of first refusal to acquire the ownership interest of the withdrawing owner. Only after the parties who are granted the
right of first refusal under the agreement have formally declined their right to purchase may the withdrawing owner transfer his ownership interest to an outside party, such as a charity. Again, this scenario does not preclude a charitable gift of the ownership interest. In such a
case, the prospective donor must take the necessary steps to provide proper notice to the relevant parties of his intention to transfer his interest, allow any required time period for the exercise of the right of first refusal to pass, and adhere to any other particulars specified under the agreement.
Finally, as a last resort, if certain provisions of the buy-sell or business continuation agreement preclude or do not allow for the transfer of an existing ownership interest to an outside party, then it may be necessary to amend the agreement before a charitable gift of the business interest may be considered. If this seems to be necessary, a thorough review of the document should be conducted to determine the possibility and manner in which an amendment may be made.
After the closely held business interest has been successfully conveyed to a charitable organization or qualified charitable trust, the charity or trustee must then consider issues surrounding liquidation of the closely held interest. As with the transfer of the interest from the donor to the charity or qualified trust, the provisions of the buy-sell or business continuation agreement can have significant consequences for the
charity as a newly established owner of the business interest. Specifically, the provisions of the agreement should be closely reviewed prior to acceptance of the gifted interest in the business to ensure that a prearranged transaction will not occur upon the subsequent disposition
of the interest by the charity.
Accordingly, great care must be taken to ensure that the documentation which governs the transfer of a business interest must not be drafted so as to create an obligation of the donee charity to sell the donated interest to a purchaser that is prearranged prior to the gift. It is, however,
permissible for the business entity or the remaining business owners to hold a right of first refusal to purchase any outstanding business interest from a withdrawing owner. Such a right does not impose upon the donee charity an unavoidable obligation to transfer (by redemption or sale) the gifted interest to a specific party. A right of first refusal merely creates an opportunity for the holder of the right to acquire the interest should the donee charity elect to make it available.
Transactions involving closely held securities can be rather involved.
Conclusion. While many gifts of publicly traded stock are relatively straight forward, transactions involving closely held securities can be rather involved. In any case, a careful evaluation of the issues surrounding the gift and effective communication among the donor, the donor’s professional advisors and representatives of the donee organization can usually result in a successful gift transaction that meets the donor’s objectives and provides meaningful impact to charity.