Business owners who are considering selling their company and have charitable intentions can implement a few strategies to make the transaction tax efficient. One strategy often overlooked is donating shares of the company to charity before the sale.
When executed properly, this pre-sale gift of closely held stock can avoid capital gains tax on the donated shares, transfer the value to a charitable vehicle, and direct proceeds toward causes of the owner’s choice. While this can be an efficient tax-saving and philanthropic strategy, there are a few crucial considerations to ensure it is enacted effectively.
Mechanics and Benefits
Rather than selling the business in full and donating a portion of the after-tax proceeds, shares of the company can be transferred directly to a donor-advised fund (DAF) or similar charitable vehicle before the sale closes. The charity participates in the transaction, receives its proportionate share of the proceeds, and the seller receives a charitable deduction for the fair market value of the shares contributed. The core advantages include:
- Capital Gains Relief: The seller can eliminate the tax that would otherwise apply to appreciation in the shares donated, which is often the single largest tax event of an owner’s life.
- Greater Philanthropic Impact: Donating appreciated shares before a sale can allow for a significantly larger charitable gift than contributing after-tax cash.
- Flexibility Through a DAF: Once the sale of the business closes, proceeds can be granted to qualified charities on whatever timeline the donor recommends, whether that be immediately or over many years.
Timing the Gift Appropriately
The tax benefit depends on this strategy being implemented with careful planning and deliberate timing. Donation of company shares cannot be made too close to the sale. If the charitable gift is made at an inappropriate time, the IRS can argue the income from the sale was already earned and that a transfer of stock right before closing does not change the owner’s tax obligation.
A contribution is likely considered too late if any of the following exist at the time of gifting:
- All material terms have been agreed upon between buyer and seller
- The board or shareholders have approved the transaction
- Due diligence is substantially complete
- A closing date has been scheduled
In practice, this means planning must begin before a buyer is selected but far enough in the process to understand the path forward.
Other Considerations for Effective Giving
While timing may be the most crucial factor in the eyes of the IRS, there are additional items to consider if a seller would like to implement a tax-efficient gifting strategy.
- Appraisal Standards: The IRS requires a qualified appraisal for gifts of non-publicly traded stock. A valuation that is incomplete or inconsistent with the eventual sale price is one of the most common triggers for scrutiny. This is an easier risk to mitigate with early planning.
- Entity Structure: The mechanics of the gift vary depending on whether the business is a C Corp, S Corp, or LLC. S Corp shares, or stock of LLCs taxed as partnerships, can be subject to unrelated business taxable income (UBTI) and trigger unrelated business income tax (UBIT). Not all taxes for these types of donated stock can be avoided but, if planned properly, the tax rate can be greatly reduced.
- AGI Limitations: There are limits to the deduction an owner can take in the year the gift is made. For gifts of appreciated stock made to charities with public charity status, 30% of AGI applies. For private charities, 20% of AGI applies. Unused amounts can be carried forward for up to five years, which can be modeled for tax savings in future years.
- State-Level Variation: Federal capital gains treatment does not automatically carry through at the state level, and the net benefit can differ meaningfully depending on the owner’s state of residence.
Conclusion
For owners with meaningful philanthropic goals and significant appreciation of the business, this strategy is worth understanding long before a sale is on the horizon. The pre-sale gift of closely held stock can reduce the tax burden on what is often the largest financial event in a business owner’s life while enabling a more meaningful commitment to the causes that are most important to the seller.
Implementing this strategy requires careful planning by an experienced team of advisors. Crewe has professionals who can assist through every step of the process. Crewe Capital works closely with Crewe Foundation and Crewe Advisors to manage the sale of the business, establish and fund DAFs, and provide tax planning and strategy throughout. We would be happy to discuss how this, or other strategies, can help make the sale of your business successful.
Investment banking services are provided by Crewe Capital, LLC, member FINRA/SIPC. Investment advisory services, including private wealth management services, are provided by Crewe Advisors, an SEC-registered investment advisor. Crewe Capital and Crewe Advisors do not provide tax, legal, or accounting advice. This material has been prepared for informational purposes only, and is not intended to provide, and should not be relied on for tax, legal, or accounting advice. You should consult your own tax, legal, and accounting advisors before engaging in any transaction.
