Don’t Get Caught Off-Guard – Holt Consulting (2024)

Gifts of private stock can be incredibly valuable, but they come with some additional complexity you don’t find with public stock. I’ve seen a number of charities get themselves into sticky situations with gifts of private stock, because they didn’t understand some important, but basic details. For example, they get stuck owning it long-term because there is no market to sell it. They are assessed taxes or penalties they weren’t expecting. They are required to contribute cash to the company to cover expenses or liabilities.

With any non-cash gift, you want to go in with your eyes open. You want to know as much as you can about the asset before you accept it. Before we get to the things you’ll want to know, let’s go over some basics of private stock.

First off – private stock is different from public stock – which is probably more familiar to you. Publicly-traded stocks are traded on a public market like the New York Stock Exchange, Shenzhen Stock Exchange of China, and the Toronto Stock Exchange of Canada. Most countries have a public stock exchange. Virtually anyone can purchase stock available at these exchanges.

Privately-held stock is not traded on an exchange. It is owned by an exclusive list of people – often members of just one family. These companies are referred to as “private” or “privately-held”, because their bylaws restrict ownership to a set group of people. These companies are often smaller than public stock companies, but not always. Sometimes they are massive global enterprises.

Thankfully, many of the tax rules for Privately-held stock are pretty much identical when it comes to donations to charity. Privately-held stock is a capital asset and it comes with much of the same favorable tax treatment as other capital assets like real estate and public stock. Let’s review.

When you give a long-term capital asset like Privately-held stock, the income tax deduction is based on the fair market value of the shares on the day of the gift, regardless of what you paid for it (as long as it’s been owned for at least a year and a day). Simply put, if you paid $5.00 for a share of stock 10 years ago and today it’s worth $25.00, your deduction for a gift of that share of stock would be $25.00. That’s basically $20.00 of deduction for FREE!Additionally, you avoid recognition of the capital gain when the gift is made. That means you don’t have to pay capital gains tax like you would if you sold the stock. When it comes to charitable deductions, not all assets receive this special treatment.

It is worth noting that, unlike public stock, private stock must be independently valued to determine the deductible amount. The valuation must come in the form of a Qualified Appraisal. These kinds of appraisals have specific requirements outlined by the IRS.

Privately-held stock comes in a variety of forms, such as C Corp, S Corp, Partnership, Limited Liability Corporation, etc. Regardless of which type you’re dealing with, there are always some basic questions to consider at the outset.

• What does the donor own?
• What can the donor give?
• What liability comes with the shares?
• What risk comes with the shares?
• What is the charity’s exit plan?

What does the donor own?

In many cases I’ve dealt with, the donor wishes to donate an asset of the company, such as a piece of real estate. If she is the sole owner of the business, she may consider herself the owner of the business assets as well. That isn’t the case. She owns shares in the business. The business owns the assets. It’s important to remember that if the business assets (like real estate, machinery, inventory) are donated, the business will be the donor – not the individual. That can make a significant difference in the financial benefit of the gift to the donor. Sometimes it’s the best choice for the donor, but details of both options (gift of stock vs. gift of assets) should be thoroughly examined by her tax and legal advisors.

What can the donor give?

Many Privately-held businesses adopt “Buy-Sell Agreements” or “Cross-Purchase Agreements”. These documents outline who can own shares of the business and under what circ*mstances shares can or must be sold. That’s how they keep the shares from being sold to anyone outside the pre-established group. Most agreements that I’ve encountered don’t specifically allow for a charity to be a shareholder. If that’s the case, the company will probably need to amend the buy-sell/cross-purchase agreement to allow for donations of shares to charity. To do that, the shareholders will have to agree to make that change. If the donor is the only owner, it should be pretty easy to make that change.

What liability comes with the shares?

Depending on the way the business is incorporated, shares given to charity come with different levels of risk (legal, financial, etc.).

There is an important liability situation to be aware of when it comes to income tax imposed upon charities that own some types of privately-held stock. It’s called “Unrelated Business Taxable Income” (UBTI). When charities own part or all of a business that isunrelatedto its mission, the charity can be subject to UBTI and the rate is quite high. It’s equal the highest corporate tax rate – whatever that happens to be at the time. There is a reason behind UBTI. Congress doesn’t want charities operating commercial businesses and avoiding income tax due to their tax-exempt status. It would give them an unfair advantage over for-profit businesses. Charities can operate income tax-exempt businesses that further their mission. A good example is a charity that works to help people in third world countries earn a living wage operating a “fair trade” farm and selling the produce.

It is worth noting that a charity organized as a trust, rather than a corporation, may not be subject to UBTI.

What is the charity’s exit plan?

The vast majority of charities do not want to be a long-term shareholder of a Privately-Held Business. They want to liquidate the shares as soon as possible after receiving them and apply the sales proceeds to their mission. Since the shares aren’t sold on a public exchange and can only be owned by a set number of individuals, the market for sale is limited. There may not be an interested buyer for the shares at any given time. Therefore, the charity needs to assess the marketability of the shares prior to accepting the gift.

Gifts of private stock offer enormous opportunity for both charities and donors, but both groups should be well-informed and advised when considering these kinds of gifts. They are complex assets and must be treated as such. That being said – don’t shy away from them. Dig in, learn about the stock and educate yourself on how to make a decision whether to accept or decline.

For a more complete analysis of gifts of privately-held stock, such as the information you’ll need to gather, how to assess for opportunity and risk, and whether private stock can be contributed to a Gift Annuity or Charitable Remainder Trust – check out my new book, Turning Wealth Into What Matters – recent Gold Medal Winner for Best Business Book of 2023.

Take your learning even further with the online School for Non-Cash Gifts. There you will find an on-demnd course dedicated to privately-held stock and much more!