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A recent Fidelity Charitable study finds entrepreneurs leading the way in philanthropy. Entrepreneurs donate on average 50% more than others. Philanthropy is particularly top of mind when owners are making plans to sell the business. Nearly 68% have plans to donate to charity in conjunction with that transaction. (1)
The idea of retiring and selling the business can be daunting. The company you have spent your career building may have multiplied in value, and the complexities can be difficult to navigate. Add to the mix that this is perhaps your most important wealth triggering event- holistic wealth and legacy planning must be undertaken. Donation of privately held business interests can be an effective and tax-efficient way to achieve charitable and legacy planning goals.
For many Founders, the original cost to start the business may have been low to zero. The sale will trigger a large Capital Gains Tax. A donation of some of the ownership interest, prior to the sale, provides a tax deduction for the fair market value of the shares, while also minimizing taxable capital gain for the portion given to charity.
Summarized below are important considerations outlined in the Fidelity Charitable paper, Five Essential Tips for Donating Your Business Interest Before You Exit.
- Prepare to Donate Early. Timing is essential. When donating privately held assets to charity, conversations must start early. The gift will have to be completed prior to finalization of the sale. Business exit opportunities can come together quickly, so working with experienced experts early can facilitate the legal transfer without delaying the sale, while maximizing the tax efficiency and philanthropic impact of the transfer.
- Ensure Company Documentation is in Order. Company documents, like shareholders agreements, or membership agreements, should be reviewed to see if there are any transfer restrictions. And there may be “first rights of refusal” clauses, that may need to be waived. Due to the owner’s philanthropic intent, these restrictions are often handled with a simple waiver or consent by the other shareholders. Often the other shareholders find the charitable tax savings quite appealing and decide to participate with their own shares.
- Don’t Ignore the Appraisal Requirement, and Don’t Procrastinate. While much is made of timing the gift appropriately, nothing matters like the qualified appraisal of the donated assets. For the tax deduction, the donor must obtain a qualified independent appraisal to value the shares as if the date of the gift. This can be done no more than 60 days before the gift, but any time prior to filing the return that includes the donation. So while the appraisal needn’t be completed prior to the tax filing, the donor should engage early in the planning process to get a clear picture of valuation and possible discounts in the deductible amount.
- Choose Your Charitable Giving Strategy Wisely. (2) Donors have a variety of choices in charitable “vehicles.”
- Donate to an Operating Charity. Fair Market Value tax deduction (subject to a 30% AGI limit). It may be important to note that many organizations are mission and program focused and may not have the expertise to efficiently handle the contribution of illiquid assets. This could result in delays, costs and complications.
- Donate to a Private Foundation. Tax deduction is generally the lower of Cost Basis or Fair Market Value (subject to a 20% AGI limit). The donor will have greater flexibility in philanthropic work, but these tax deduction limitations can be substantial.
- Donate to a Donor Advised Fund program. Fair Market Value tax deduction (subject to a 30% AGI limit). A DAF program can be optimal for the donation of business interests with respect to cost, flexibility, simplicity, and tax benefits. Some DAF sponsors have in-house expertise to facilitate complex gifts.
- Utilize Experts to Help Navigate the Process. It is important to leverage the expertise of those familiar with the donation of business interests. Enlist the help of your trusted advisors, such as CPA. Attorney, or Financial Advisor. They have a holistic view of your situation and your long-term goals. And make sure your chosen charity also has the expertise to work with non-publicly traded assets.
If you or anyone in your network is contemplating a partial or total sale of the business, whether it’s an exit strategy or bringing in a partner, Capstone Business Advisors is here to help. Feel free to contact us or Fidelity Charitable.
1. Fidelity Charitable, Entrepreneurs as Philanthropists, September 2019
2. Facts and circumstances can differ. Be sure to consult your Tax Advisor.