Many donors keep a significant part of their prosperity in illiquid securities, such as interests in carefully held businesses and limited stock of corporations, or alternative investments, such as hedge funds and private equity funds. This model of Professional Notes provides a wide overview of the problems involved when a donor wants to invest in a charitable present with passions in closely held businesses and other illiquid investments.
In the section on hedge money and private collateral partnerships, we highlight a unique charitable giving opportunity available in 2017 for hedge finance managers who have deferred some of their compensation through the use of offshore vehicles. A donor’s tax treatment for a charitable gift of illiquid securities depends upon three things: the type of security contributed, the donor’s keeping period for the security, and the type of charity to which it is added.
For a contribution of an interest in a relationship without liabilities, the fair market value deduction will be reduced to the extent the relationship owns ordinary income assets. The portion of the gift due to the partnership’s ordinary income assets will be deductible and then the extent of the partnership’s basis in those assets. By contrast, only a gift of securities that meet the description of “qualified appreciated stock” qualifies for a fair market value deduction when added to a private non-operating base.
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Qualified appreciated stock is defined as stock in a company that market quotations are plentiful on an established securities market and that is a long-term capital asset. This rule for private foundations has limited and comparatively uncommon exceptions (e.g., a gift to a “pass-through” base that distributes the present within a specified time).
The Internal Revenue Code (Code) generally enables a charitable deduction as high as to 30 percent of an individual donor’s adjusted gross income for gifts of long-term capital gain property contributed to a public charity or a private operating base. But a present of such stock to an exclusive non-operating base is ordinarily deductible only up to 20 percent of modified gross income. Any unused deductions may be carried for five more tax years forwards.
A charitable gift of an interest in a carefully kept business requires careful planning. An integral concern for the owners of the business enterprise could be the impact of adding an outsider as an owner. Furthermore, charitable organizations typically do not want to hold illiquid investment possessions, particularly interests within an operating business (as specific from, say, an exclusive equity fund or a hedge account).
To address these concerns, the redemption of the charity’s interest at a reasonable market value immediately after the present is completed may be appealing to both the charity and other owners of the business enterprise. To avoid triggering the inherent capital gain, however, the contribution and following redemption must occur without prearrangement between the donor and the charity.
That is, there must be no pre-existing obligation that the charity will tender its donated interest or that the business enterprise will redeem the charity’s interest. If the charitable recipient is a private base or a donor-advised finance, the use of the excess business holdings guidelines must also be considered. In the case of gifts and bequests, there’s a five-year “grace period” to bring holdings within permitted levels, and, in special cases, the IRS may exercise its discretion to grant a number of extensions.
It will be important to identify this problem before the gift is made, so there may be a plan set up (e.g., the probability of redemptions or sales to unrelated third parties) to bring holdings within permitted levels. Newman’s Own Foundation-established by actor Paul Newman, who died in 2008-is seeking repeal of the rules so the Foundation can continue to own completely of the well-known food company that Newman bequeathed to the Foundation.