S Corporation, or limited liability company? That’s a question many family businesses grapple with in their formative stages. For years, S Corporations were frequently preferred for small businesses that wanted the protection of a corporate structure versus a traditional partnership. In the 1990s, limited liability companies, or LLCs, rose in popularity because they offered both favorable tax treatment and corporation-like protections. In recent years, lower tax rates have contributed to the resurgence of traditional C Corporations as a viable structure for a business.
Since the adoption of laws and regulations decades ago making them advantageous, many S Corporations and LLCs have grown into thriving, highly-valuable businesses that are owned by your clients and are therefore now the subject of your estate planning work. So, too, have grown many clients’ desires to unlock these assets to fulfill charitable goals.
Many advisors find themselves discussing the benefits of donating S Corp stock to a charity prior to the sale of a business, but rarely do advisors feel prepared for that discussion with a client. That’s why it is important to be generally aware of the rules before the topic arises in a client meeting. A discussion with your client is especially important as business succession plans are crafted because many business owners want to minimize tax liability and also give back to the communities where their businesses have flourished. As an advisor, you have a responsibility to understand what might be possible.
Donating S Corp stock to a charitable organization is an important option that your clients will want to consider, and understanding the complexities is critical. Three factors are particularly important:
- This idea must be addressed early in the process of business succession planning, especially prior to any formal discussions about a sale. Indeed, the IRS is known for its keen eye in spotting transactions that could be construed as resulting in “anticipatory assignment of income,” especially where a charitable deduction is involved. At the same time, many charitable organizations prefer not to hold hard-to-value assets like S Corp stock for more than a few years. Balancing these factors requires thoughtful planning and timing.
- Private foundations and certain donor-advised funds at trust-form institutions (which then trigger the trust tax rates) are permissible shareholders of S Corp stock. Moreover, public charities have been eligible S Corp shareholders since 1998. Before you explore an S Corp gift to a charity, be sure to review the rules related to permissible S Corp shareholders.
- Charities holding S Corp stock may be subject to Unrelated Business Taxable Income rules. Be sure to show your client various alternative calculations to determine the most cost-effective structure for each transaction alternative.