By Stephen C. Lande
The S Corporation Association of America modestly asserts that, “Small businesses are the cornerstone of the American economy and S corporations are the cornerstone of America’s small business community.” It describes the S corporation as the most popular corporate structure in America and declares the enactment of subchapter S of the tax code in the midst of the high-tax era of 60 years ago as nothing less than a boon to private enterprise.
A business corporation avoids double taxation (first to the corporation and then to its shareholders) by electing to be treated as an S corporation. The financial liability of the business for which S corporation shareholders are responsible continues to be limited, while only its shareholders are taxed.
Many of your clients may be small business owners. Accordingly, most of their assets may be tied up in an S corporation and it may be their primary source of income, or they may hold specific investments in this manner.
Charities have a special affinity for these individuals and families who often contribute great wisdom, leadership and an entrepreneurial spirit to the charities they favor, along with their generous financial support.
Remember, it used to be that only individuals were allowed to own S corporation stock, which meant that the contribution of such shares to charity resulted in dire consequences for the S corporation. The Small Business Job Protection Act of 1996 fixed that, and charities are now permitted to own and hold S corporation stock. My reference here is to public charities, not private foundations, because of the likelihood of an IRC Section 4943 excess business holdings problem.
In the process of planning, you and your clients may come to the conclusion that their S corporation holdings present a perfect opportunity for charitable gift planning, tax and estate, and maybe even business succession planning all rolled into one. When this occurs, it is usually accomplished in one of two ways. Here’s a brief overview.
Gift of S corporation stock to charity by the donor: A charitable contribution of S corporation stock happens in the usual way. The stock is transferred to the charity, a qualified appraisal by an independent appraiser must be obtained, and the gift is appropriately documented. The value of the donor’s charitable deduction will no doubt be reduced if the gift represents a minority interest, and there are some special rules that apply to these gifts. The amount of the donor’s charitable deduction must be further reduced by any portion of the value of the stock that is attributable to appreciated assets owned by an S corporation the sale of which would generate ordinary income, if any. Also, any income that flows through to the charity is unrelated business income and tax must be paid. This will be a concern to the charity, but the corporation may make distributions to cover the tax. Capital gains tax must be paid on the disposition of any of the shares, and it may even work out better for the donor to sell the S corporation stock and donate proceeds.
Direct gift of corporate assets to charity by the S corporation: An S corporation may make a direct charitable contribution of its assets. A contribution of cash, liquid investments or real estate may accomplish all of your client’s charitable and other planning purposes for the gift while avoiding unrelated business income to the charity. S corporations are not subject to the C corporation 10% giving limitation. Such direct contributions are deductible proportionately by all the S corporation’s shareholders, which means, as a practical matter, that all must agree to the gift. The individual shareholder’s contribution deduction is subject to the individual giving limitations, and may not exceed his/her basis in the stock. Carryover is an option. These gifts may even work to establish split-interest trusts, which can’t own S corporation stock.
This brief article is not intended to be an exhaustive review of the subject of S corporation contributions. The hope is that shareholders contributing S corporation stock or S corporations contributing assets directly to charity will be a consideration as you advise and plan for clients that hold S corporation shares. We urge you to run the numbers. And note that with all the rules, tax considerations and limitations, there are even situations when selling the property and donating the proceeds can yield a more favorable result.
S corporation stock represents only one example of an illiquid asset. Others include closely held stock, restricted stock and stock options. Each holds its own possibilities and can be used to fund endowments or donor advised funds. The rules are different for gifts to private foundations, and they aren’t covered here. S corporation stock may not be held by charitable remainder trusts but they can receive gifts of its property.
The resources of The Foundation of the Greater Miami Jewish Federation are available to you and your clients in complete confidence and without obligation as you consider gifts of S corporation stock and other closely held assets. These gifts may offer your clients the opportunity to fulfill their charitable objectives in a tax-wise manner, inspire and engage the next generation of their families and create a lasting legacy. For more information, please contact Foundation Director Steve Lande at firstname.lastname@example.org, or 786-866-8623, or consult jewishmiami.org.
Steve Lande is director of The Foundation of the Greater Miami Jewish Federation and serves as Federation’s Authorized House Counsel. Prior to joining the Greater Miami Jewish Federation, he directed the Jewish Federation of Greater Pittsburgh’s endowment program for 18 years. A native of Iowa, Lande earned a law degree from Drake University and practiced law in Des Moines before joining the professional staff of the Pittsburgh Jewish Federation.
South Florida Legal Guide 2015 Financial Edition