By Coralie Pledger, CPA
Charitable giving can encompass so much more than cash donations. One of the unique aspects of Austin Community Foundation is our ability and flexibility to accept gifts of closely held business interests.
Many executives and entrepreneurs hold a significant portion of their wealth in illiquid securities. These assets likely have a low tax basis and appreciate substantially, resulting in notable capital gains taxes when sold. Donating these types of securities creates ideal charitable giving opportunities.
When you donate illiquid securities held for more than one year to a donor-advised fund at ACF, you receive significant tax benefits and unlock more funds for charity. In most cases, the capital gains tax that would be incurred if you sold the security outright would be avoided, and you may also claim a charitable deduction for the fair market value of the donated security.
The IRS generally permits a charitable deduction for the donation of interests of up to 30% of an individual donor’s adjusted gross income for gifts of long-term capital gain property contributed to a donor-advised fund.
ACF has the resources and expertise for evaluating, receiving, processing, and liquidating this type of gift through a donor-advised fund. Be aware that gifts of appreciated illiquid securities can require detailed tax analysis and due diligence. This article is not intended to provide tax or legal guidance. Please consult your tax or legal advisor when planning a donation of illiquid securities.
Types of Securities
The type of security donated can impact the donor and the public charity’s tax treatment. Illiquid securities typically take the form of privately held interests in C corporation stock, S corporation stock, limited partnerships (LPs), limited liability companies (LLCs), restricted stock (Section 144), and alternative investments such as hedge funds and private equity funds. Carried interests and warrants to purchase securities can also qualify for charitable donations. The entity’s form will affect the tax consequences of a charitable gift of an equity interest.
Considerations for Donating Complex Assets
Transferability – Illiquid interests may be subject to transfer restrictions or have specific legal or governance requirements for transfer. During due diligence, it’s essential to identify any conditions related to the interests and what specific authorizations or approvals are needed to accomplish a transfer.
Timing – If the privately held business interest is being considered for sale or an initial public offering, the transaction terms should still be under negotiation at the time of the gift and not subject to a contract. If under contract, the IRS would consider it a prearranged sale. The IRS could then consider the income already earned by the donor under the doctrine of “anticipatory assignment of income” and require the payment of capital gains taxes by the donor.
Contingent liabilities – LPs and LLCs may have contingent liabilities such as capital calls, clawbacks, or taxes. During due diligence and review of the governance documents of the entity, ACF will identify and work with donors to ensure that contingent liabilities can be satisfied either by cash distributions from the entity or by the donor providing additional cash or liquid donations.
Taxes – Generally, passive income generated by donated illiquid securities, such as capital gains, dividends, and interest income, is not taxable when held by a public charity like ACF. However, ordinary income generated by LPs or LLCs may be taxable as unrelated business taxable income (UBTI). Additionally, S Corporation securities have unique tax treatment that may result in the public charity incurring taxes while holding the S Corporation securities or at the time of ultimate sale.
Because hedge funds often raise money through borrowing, they are likely to produce UBTI due to the application of the debt-financed IRS income rules, so the hedge fund structure should be considered as part of the due diligence process. The donor should identify and assess potential tax liabilities as part of their tax planning process. Similar to addressing contingent liabilities, ACF will work with the donor to ensure there’s additional cash or income available to cover these taxes.
Disposition plan – ACF works with the donors before gift acceptance to make a plan for the disposition of the asset within a reasonable time frame. Additionally, the IRS requires certain interests to be sold in whole or in part within 5 years. ACF will assist donors in identifying whether these IRS rules apply and should be considered in the disposition plan.
Valuation and appraisal requirements – The IRS requires an appraisal by a third-party qualified appraiser on their tax return (Form 8283). Among other requirements, a qualified appraiser of contributed noncash gifts documented has met certain minimum education and experience requirements and regularly prepares appraisals for pay.
Appraisals of illiquid securities can often be complex and costly. Appraisers typically apply discounts for lack of marketability, reducing the appraised fair market value and, consequently, the donor’s tax deduction. In particular, appraisals of private equity funds or carried interests may be particularly complex depending on the fund or interest structure and its portfolio holdings.
Our staff has the expertise and experience to help you navigate complex gift transactions. Contact us to learn more about how you can maximize the charitable impact of your assets.
Coralie Pledger is the chief financial officer at Austin Community Foundation. She has over 30 years of experience as a Certified Public Accountant, chief financial officer, and consultant providing accounting, financial, investigative accounting, and regulatory services.