If your client base includes business owners, you probably weren’t surprised by this observation in a recent Wall Street Journal article about the “stealthy wealthy”: “Behind a paycheck, the largest source of income for the 1% highest earners in the U.S. isn’t being a partner at an investment bank or launching a one-in-a-million tech startup. It is owning a medium-sized regional business.”
What’s more, the chances are very good that most of your business-owner clients are charitably inclined. Indeed, more than 90% of small business owners have supported charities and community activities in the last year.
This means that you and other tax and estate planning advisors ought to have at least a basic level of knowledge about the benefits and mechanics of giving closely-held business interests to charity. When properly executed, this technique can be extremely effective in achieving the client’s financial and philanthropic goals.
Here are three very important components of this strategy:
Stop before you use a private foundation.
Some of your business owner clients probably have established a private foundation. However, a private foundation is not the ideal recipient of private business interests. Donating closely-held stock to a fund at the FM Area Foundation is generally more tax effective than giving it to a private foundation due to several key differences in how the IRS treats these gifts. When your client donates closely-held stock to the FM Area Foundation, your client can typically deduct the full fair market value of the stock, up to 30% of adjusted gross income, and avoid paying capital gains tax on any appreciation. By contrast, if your client donates the same stock to a private foundation, the deduction is limited to cost basis up to only 20% of AGI, which is a significantly less favorable tax outcome.
Mind the timing.
Encourage a business owner client to start planning for a gift of closely-held stock before putting out feelers to potential acquirers and absolutely before any part of a deal is inked. This is crucial because a gift to charity will avoid substantial unrealized capital gains accrued in the business over the years, only if the gift and the sale are genuinely separate events, preventing the step transaction doctrine. Careful planning will help ensure that the client’s fund at the FM Area Foundation will receive 100 cents on the dollar for the portion of the stock it owns, and the deduction won’t be thrown out.
Respect the valuation rules.
Counsel your clients about securing a proper valuation for charitable deduction purposes when the business interest is contributed to the fund at the community foundation. Valuation has always been critical in any tax or estate planning strategy. Recently, the additional wrinkle presented by the Supreme Court’s decision in Connelly v. United States makes things even more interesting. The Connelly decision impacts how business interests are valued for estate tax purposes. In Connelly, the Supreme Court held that life insurance proceeds indeed ought to be included in the value of a company without offsetting the redemption obligation. This could translate to higher taxable estates for your business owner clients, creating further incentive to leave a portion of closely-held stock to charity. The decision is also a reminder that careful planning can potentially avoid pitfalls.
As always, please contact the FM Area Foundation anytime the topic of charitable giving arises in client conversations. We are honored to be your first call on all matters of philanthropy. Most of the time, we can help. If not, we will point you in the right direction.
