How donating business interests before selling a company can allow you to give more to charity
Do you own an interest in a privately held LLC or limited partnership that may have a future liquidity event? Donating a portion of your interests to charity ahead of time could result in two major benefits:
1. An income tax charitable deduction for the fair market value1 on the date of contribution.
2. Minimized capital gains tax; capital gains tax generally does not apply to assets donated to charity.
Donate LLC or limited partnership interests into a donor-advised fund such as the Giving Account at Fidelity Charitable and you may see even more advantages:
1Fair market value, as determined by a qualified independent appraisal.
Because Fidelity Charitable is a 501(c)(3) public charity, capital gains taxes don’t apply on its sale of the LLC or limited partnership interests you donate. That means your tax deduction AND your gift to charity can be larger. Here’s an example:
2This assumes all realized gains are subject to the maximum federal long-term capital gains tax rate of 20% and the Medicare surtax of 3.8%. This does not take into account state or local taxes, if any.
3Assumes no Unrelated Business Income Tax (UBIT) and does not take into account limitations on itemized deductions.
Make a meaningful difference at your college alma mater.
Provide college scholarships for foster children.
Scarlett is an executive at a privately held California-based LLC, which was likely to be sold in the next few months. She owned significant interests in the LLC as one of the initial employees.
As a proud MBA graduate, she wondered if a portion of the LLC could be used to provide meaningful support for her alma mater.
She spoke with her CPA, who suggested it may be possible to make a charitable contribution of the LLC interests. Together they discussed the contribution with Fidelity Charitable and, upon close review of the facts and circumstances, determined she could contribute the LLC interests to Fidelity Charitable because a sale was not yet certain to happen.
A few months after Scarlett's contribution, Fidelity Charitable identified a buyer and sold the LLC interests. Fidelity Charitable used the sale proceeds to fund Scarlett's Giving Account, and she recommended a grant to her business school.
Because capital gains tax did not apply to Fidelity Charitable's sale of its interest in the LLC, Scarlett was able to make an additional grant recommendation to another charitable organization, one that provides college scholarships to foster kids.
Scarlett was entitled to a fair market value tax deduction.4 Additionally, she dealt with one charity and one set of paperwork to accomplish the charitable contribution of the business interests as simply and efficiently as possible.
4Fair market value, as determined by a qualified independent appraisal.
This hypothetical case study is provided for illustrative purposes only. It does not represent an actual donor, but is meant to provide an example of how a donor-advised fund can help individuals give significantly more for the causes they care about.
While charitable organizations are generally exempt from income tax, contributions of certain “pass-through entities” that are taxed as partnerships rather than as corporations can create tax liability for the charity in certain circumstances.
Partnerships and most multi-member LLCs are taxed as flow-through entities; thus, if they engage in an active trade or business or have acquired assets with debt, the charity may be subject to Unrelated Business Income Tax (UBIT) on its share of the entity’s income. Gifts of indebted interests may trigger negative tax consequences for donors and recipients. In addition, the charitable deduction, for those who itemize, must be reduced by the amount of ordinary income that would have been realized if the interest had been sold at fair market value on the date contributed. Always consult with a tax advisor prior to donating interests in flow-through entities.
While tax-exempt charitable organizations do not generally pay federal income tax, certain “pass-through entities” that are taxed as partnerships rather than as corporations can create unrelated business income tax (“UBIT”) liability for a charity. As a “pass-through” entity, a partnership is generally not taxed at the entity level like a corporation. Rather, the partnership’s income, deductions, losses and gains “pass-through” to its partners providing one level of tax rather than two levels of tax like in a corporation. While this can be a tax-efficient structure in certain instances, charitable contributions of partnership interests involve complex tax issues for both the donor and the recipient charity.
UBIT liability may result from trade or business income allocated to the charity by a partnership during its holding period. Additionally, proceeds from the sale of a partnership interest attributable to “debt-financed income” may result in UBIT liability. To the extent Fidelity Charitable has UBIT liability arising from a contribution, it will allocate such costs to the applicable Giving Account.
In addition to these complicated and fact-specific matters related to UBIT, each donor should consult the donor’s tax and legal advisors with respect to the donor’s own tax treatment, including, but not limited to, limitations on deductions for portions of gain that would have been short-term capital gain to the donor if he or she were to sell the contributed partnership interest and the potential tax implications of contributing partnership interests with non-recourse debt.
Certain publicly-traded entities (such as master limited partnerships or “MLPs”) may also be “pass-through entities” taxed as partnerships. Although traded publicly on an exchange, those entities can present the same complex tax issues discussed above. Please call prior to making a contribution of equity in a MLP or any other publicly-traded “pass-through” entity.
Please note that this page only discusses contributions of entities taxed as partnerships. While many multi-member LLCs are taxed as partnerships, certain LLCs may be treated for federal income tax purposes as disregarded entities, C corporations or S corporations. The issues presented for such LLCs may be different than those discussed above.
All donors should discuss contributions of partnership interests with experienced tax or legal advisors. Neither Fidelity Charitable nor Fidelity provides tax or legal advice.