The sale of a major business asset often represents the culmination of many years of work. It might be a family business, a real estate investment or holdings in a publicly traded company where there will be significant income or capital gains from a sale. By creating a private foundation, the seller may avoid or reduce taxes while retaining control over the proceeds to be used for charitable activities.
The following case studies illustrate potential opportunities to mitigate taxes during a wealth creation event while earmarking certain assets for charitable use.
Case Study #1: Entrepreneur with a Cash Buyout Offer
Craig founded and operated for-profit career colleges through a privately held corporation. After years of successful operations, Craig received an all-cash offer to sell. This presented Craig with a dilemma: should he contribute corporation stock to his family foundation prior to executing a sale agreement or sell the stock and make a cash contribution to his foundation?
After consulting his tax advisor, Craig concluded that selling the stock and making a cash contribution to his foundation was the optimal choice. Had he contributed the privately held stock, he could only claim a charitable deduction for his adjusted basis in the stock, not its fair market value as reflected by the sale. From his foundation’s standpoint, although gifts of stock aren’t treated as excess business holdings (EBH) for 60 months, the foundation eventually would have to sell most of the stock to fall within EBH limits and avoid a violation, even if the anticipated sale didn’t close.
Case Study #2: Suddenly Valuable Stock Options
A long-time executive at a public company, Patricia held non-qualified stock options (NSOs) to purchase 100,000 shares of her company’s stock at $20 per share. Due to the profitability of a new product line, the stock suddenly increased in value to $50 per share. Patricia wanted to capture this run-up and—since she didn’t need it for retirement—decided to donate it to her private foundation.
With her tax advisor, Patricia considered several alternatives:
• Contributing the NSOs themselves to her foundation
• Exercising the NSOs, selling the stock, and donating the after-tax cash proceeds to the foundation
• Exercising the NSOs, selling only as much stock as needed to cover taxes on the exercise, holding the remaining stock for at least a year to obtain long-term capital gains treatment, and then donating it to the foundation
• Exercising the NSOs and donating other appreciated property of similar value to the foundation to offset the tax triggered by the exercise
Although some types of stock options cannot be transferred by law and many stock option plans do not allow transfers or only permit them to family members, Patricia’s company’s plan permitted transfers to charity. Patricia ruled out donating the NSOs to the foundation after her tax advisor pointed out that, she—and not the foundation—would owe ordinary income tax when the foundation exercised them. Therefore, it was preferable for Patricia to exercise the NSOs herself under one of the other alternatives.
Patricia ultimately decided to donate to her foundation $3 million of publicly traded stock she had obtained years before and in which she had a low basis. She received a charitable deduction for the fair market value of the stock (avoiding tax on the significant gains), which offset the taxes she owed on her NSO exercise and resulted in a larger donation to her foundation than the other alternatives.
As these case studies illustrate, thoughtful tax planning can help philanthropically minded individuals achieve their charitable objectives when they monetize a major business asset. To learn more, visit foundationsource.com/tax-advantages.