Congratulations! If selling your business is in the plan, whether now or in the future, you’re entering an exciting time to celebrate your hard work and enjoy the rewards of what you’ve built. As you prepare for this unique wealth-triggering event, seize the opportunity to simultaneously give back to important charitable causes.
Donating privately held business interests can be a highly effective and impactful philanthropic strategy that not only makes a difference for causes you care about, but also allows you to minimize the tax burden associated with this influx of income.
For many business founders, the original cost to start their business may have been low or even zero. If your business multiplied in value throughout your ownership, selling part of your interest might come with an exciting financial windfall—and a correspondingly large capital gains tax. That’s where a sophisticated tax strategy can make a major difference in how much you can “afford” to give to charity.
A donation of some of the ownership interest provides two benefits: A charitable tax deduction for the fair market value of the donated interest and minimized capital gains exposure for the portion donated and sold by the charity rather than the business owner. Contributions made directly to charity are generally deductible at fair market value (as determined by a qualified appraisal) for up to 30 percent of the business owner’s adjusted gross income (AGI).
If this charitable strategy makes sense for you, there are several important considerations:
Timing is essential. Business exit opportunities can come together very quickly, therefore, charitable planning conversations may also need to be fast-tracked. By working with experts, the legal transfer of business interests to charity can occur without delaying the sale process; all the while maximizing the tax efficiency and philanthropic impact of the transfer.
Take this example of a situation we saw at Fidelity Charitable: A financial advisor inquired about the possibility of donating privately held shares in an agency his client founded. Unfortunately, the owner had already entered into a legally binding agreement to sell the agency. Because the deal was effectively completed and the capital gains would have been attached, a gift of his shares at this point would not have minimized his tax burden.
The agreement to sell fell through, but the owner was still interested in making a charitable contribution of some of his shares. While the agency was put back on the market, the owner legally transferred a portion of his shares to Fidelity Charitable, which became a minority shareholder in the business. Ultimately, the agency was sold and the proceeds from the sale of its interest funded the exiting business owner’s donor-advised fund. He could now continue to provide ongoing support to his favorite charities.
Even if the owner missed the window to donate his privately held interests before the sale was complete, there were still tax-smart strategies he could have deployed as part of the exit strategy. One option would have been to consider giving other highly appreciated assets in his portfolio to offset the tax impact of the high-income year triggered by the sale of his business.
Corporate governance commonly requires approval from all or a majority of shareholders, board, or managing members and general partners to allow for the transfer (including a charitable transfer) of ownership interests. Additionally, there may be rights of first refusal in favor of the company or other owners that may need to be waived before the shares can be donated to charity. Companies may also have transfer restrictions in place that would need to be amended, approved or waived before making the donation.
These restrictions are rarely burdensome enough to be a significant deterrent to tax-efficient charitable giving. Due to the donor’s philanthropic intent, these barriers to transfer are typically handled with a simple waiver or consent by the other interest holders.
While it is imperative to make the donation in a timely manner to realize the most favorable tax benefits, the timing won’t matter much without a qualified appraisal.
Generally, for contributions of non-publicly traded securities, donors must obtain an independent, third-party valuation from a qualified appraiser to substantiate the value of the charitable tax deduction that the donor is claiming on their IRS Form 1040. Appraisals can be obtained no earlier than 60 days before the date of the donation, and no later than the date the donor’s annual tax return is due (with extensions) for the year in which the asset is given to the charity. Be sure to factor the timing and cost of the appraisal into your plan and keep in mind that there are typically discounts for lack of marketability and minority interests. That means the charitable tax deduction may not equal the value the charity receives in the sale of the asset.
Donors have a variety of choices to consider when choosing where to give when they decide to incorporate a charitable donation into the sale of the business. This includes giving directly to a public charity, a private foundation or a public charity sponsoring a donor-advised fund program.
While there are benefits to each approach, it is worth noting that contributions of privately held business interests to private foundations may only be deductible up to 20 percent of the business owner’s AGI, rather than the 30 percent limit when contributing directly to a public charity, including public charities with donor-advised fund programs.
Donating to a public charity with a donor-advised fund program can maximize the net proceeds committed for broad charitable use. This is because charities lacking expertise in receiving gifts of private business interests may trigger additional administrative overhead and outside costs to process. A public charity with a complex asset team has experience and expertise facilitating a wide range of private asset donations and can efficiently process the donation.
Private foundations and public charities with donor advised fund programs allow you to diversify your philanthropy to many qualified charities over time—giving you the flexibility to support multiple causes from your single, complex asset gift in the way that works best for you.
Until recently, non-publicly traded assets were a largely untapped source of philanthropic funding, especially since many charities ask for and receive cash donations—which are the least efficient contributions for a donor. Donors and their advisors were either not previously aware of giving these assets, considered the strategy too complex or overlooked it altogether. But today, more donors are harnessing the unique power of these assets to make more impactful gifts while achieving their financial and legacy planning goals. Tax-smart, strategic philanthropy can be a powerful way for you to leverage the sale of your business for good—don’t miss this moment to make a difference.
Head of Fundraising
Karla Valas leads fundraising for Fidelity Charitable, the nation’s largest grantmaker. The expertise from her team of Charitable Planning Consultants helps advisors have more sophisticated financial planning conversations that incorporate charitable strategies, such as donor-advised funds. Ms. Valas has expertise in complex assets and previously led a team of attorneys who facilitate thousands of charitable donations of appreciated private company stock and other nonpublic assets annually. She a B.A. from Mount Holyoke College, a J.D. from New England Law and an LL.M. in Taxation from Boston University School of Law. Ms. Valas is admitted to the bar in New York State and the Commonwealth of Massachusetts.
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