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closely held stock

Will You Get a Tax Break if You Donate Closely Held Stock?


Our tax code is crafted to encourage contributions to worthy causes. In particular, the law authorizes special breaks for donations by individuals whose holdings include stock in closely held companies.

Dec 19th 2019
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Our tax code is crafted to encourage contributions to worthy causes. In particular, the law authorizes special breaks for donations by individuals whose holdings include stock in closely held companies. Typically, they’re corporations that are owned by just a few shareholders, frequently family members, as opposed to publicly held entities like Apple and IBM, whose shares are traded regularly on the New York Stock Exchange or other securities markets.

With that by way of background, let’s suppose a client I’ll call Nadine owns stock in Harrison and Lawndale (HL), a closely held company. She plans to make sizable donations to Worthy Cause (WC).

My advice: Nadine shouldn’t go the usual route and write checks. Instead, she should avail herself of a strategy that generates big tax savings when she donates some of her shares.

Done the right way, what the IRS characterizes as "contribution-redemptions" makes it possible for her to withdraw sizable amounts from her business without (1) incurring taxes on what’s withdrawn and (2) surrendering any ownership interest in the company.

There’s a two-step test for her withdrawal to qualify as tax-free. First, she contributes her stock to WC. Second, without any prearrangement, the charity sells the shares to her company.

Here’s how this technique works. Nadine owns all 1,000 shares of HL. She originally paid $1 per share for those shares, each now valued at $1,000. To fulfill her pledge of $20,000 to WC, she donates 20 shares.

In theory, WC can do whatever it wants to with those 20 shares. Yet, as a practical matter, who, other than one of Nadine's relatives or business associates, would be willing to purchase a minority interest in HL? Since WC prefers cash to owning HL shares, it offers the shares to HL, which purchases them for their fair market value of $20,000.

Net result for Nadine: First, she trims the tab with a charitable write-off for $20,000, never having parted with a penny of her own cash. Second, she’ll pay no capital-gains taxes on the appreciation on the shares given away.

Nor does WC get dinged for taxes when it sells the HL shares, as it’s a tax-exempt entity. WC winds up with a cash contribution.

As for HL, it has, in effect, paid out its funds on behalf of Nadine. My client once again becomes sole owner of all the stock.

The last step is some simple bookkeeping. HL's books will carry the shares at cost as treasury stock—shares that have been issued as fully paid to stockholders and subsequently acquired by the corporation to be used by it in furtherance of its corporate purposes.

So what does going this route accomplish? It allows Nadine to avoid the dividend income of $20,000 that would’ve been realized by her had the stock been bought directly from her by HL, and she then contributed the proceeds to WC.

I remind Nadine of a possible problem. IRS spoilsports still can intervene if WC is legally bound or can be compelled by HL to surrender the shares for redemption. In that event, warns an agency ruling, it will treat the contribution-redemption as a taxable dividend to her. The IRS spells it all out in Revenue Ruling 78-197.

I tell her not to worry about the ruling. Actually, there needn’t be any kind of promise, nudge, nudge, wink, wink.

After all, what else is WC going to do with its HL shares? Ordinarily, it makes sense for WC to convert the shares into cash by selling them; the most logical buyer is HL itself, which gets to liquidate a potentially bothersome minority interest.

Can Nadine relax? It depends. Agency approval of the contribution-redemption doesn’t bar it from asserting that the shares should be valued for less than $20,000, thereby decreasing Nadine's charitable deduction.

Best Wishes Dear Readers for a Happy New Year. I'm someone who keeps creditors at bay and bread on the table only because I've “a certain talent” for articles that demystify the Internal  Revenue Code. In the course of four-plus decades, I've written several thousand articles. They've appeared in print publications, such as Playboy, Reader's Digest and Vogue. And in electronic  outfits, most notably in AccountingWEB, where my articles debuted in April of 2014. Delve into its archive of more than 300 of those articles.