Donations of Closely-Held Stock Prior to a Change In Control – The Key to a Double Tax Benefit Is Careful Planning

When structured carefully, a donor can obtain a double tax benefit from the donation of appreciated closely-held stock to a charity. The first tax benefit is that the donor can avoid recognition of long-term capital gain income on the difference between the fair market value of the stock and the donor’s basis in that stock. Often the gain is quite substantial due to the negligible basis that donors have in their ownership interests in businesses that they have started themselves. The second tax benefit is that the donor is entitled to a charitable deduction equal to the fair market value of the donated stock. Sounds like a win/win, so what is the catch?

Many charities are reluctant to accept closely-held shares due to ownership restrictions and the difficulty disposing of such shares that typically do not have a ready market available. Thus, the topic of donating closely-held appreciated stock tends to come up when the donor’s company is the target of an acquisition or on the eve of going public. In both cases, the change of control event provides the charity with the ability to dispose of the stock relatively quickly after receipt of the donation in an already planned or anticipated transaction. The ability to dispose of the stock makes the charity more receptive to accepting the donation. The catch is that if the donation is not completed prior to the change in control event that fixes the right to income from the shares of stock, the assignment of income doctrine can come into play forcing the donor to recognize the capital gain built into the stock that the donor was hoping to avoid.   

Case Study. This was exactly the result in the recent case of Estate of Hoensheid v. Commissioner, TC Memo 2023-34, where the contribution of $3 million of closely-held stock to a donor-advised fund prior to the acquisition of the company was at issue. Unfortunately for the donor in this case, he stated in emails that his intention to donate his shares was predicated on being 99% sure that the sale of the company would occur and his actions and communications were consistent with that intent. Thus, the donation of the shares took place only two days prior to the closing of the sale transaction. The assignment of income doctrine came into play because the transaction was “virtually certain to occur” at the time the donation was made.

The donor did have some facts on his side however. First, the donor-advised fund administered by Fidelity Charitable had no obligation to sell the donated shares pursuant to a prearranged understanding. The Tax Court found that “this factor weighs against the assignment of income but is not dispositive.” Second, several contingencies needed to be met prior to closing of the acquisition, but none were found to be substantial. Sadly for the donor, these facts were not enough and the Tax Court ruled that in order to avoid the assignment of income doctrine the donor must bear at least some risk that the transaction will not close. Viewed in light of the realities and substance of the transaction, including the fact that the shares were not transferred to Fidelity Charitable until two days before the transaction closed, any such risk was eliminated and the sale was held to be a virtual certainty. Thus, the donor’s right to income was fixed prior to the donation and the assignment of income doctrine required the donor to recognize gain on the sale of the donated stock, eliminating one of the two tax benefits of the donation.

Upshot. The lesson from Hoensheid is that to avoid the assignment of income doctrine, donors need to make sure that the donation is completed before the change in control transaction becomes certain to occur… and, as a practical matter, adding a week or two between the two transactions doesn’t hurt.

To read the case in full click here.

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