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Funding Your Charitable Goals with Your Business

Authors: Matt Masterson and Brent Beene

Donor Advised Funds (DAFs) are a simple and flexible way for individuals to donate appreciated securities and direct those funds to their favorite charities.  In addition to contributing public securities or cash, investors can also use their privately held C and S Corp stock, limited partnerships or LLC interests to fund a DAF.  In addition, investors could utilize real estate or pre-IPO shares to fund a DAF.

It is difficult for most charities to accept donations of private stock as they are not equipped to handle such donations.  Accepting donations of publically traded securities is simple – they have a market value that allows the charity to easily identify the charitable contribution, and they are marketable – meaning they can easily be converted to cash.  Private stock does not have either of these characteristics – enter the Donor Advised Fund.  Some DAF’s – such as Schwab, Fidelity, or your local DAF (such as Community Foundation of New Jersey) have the ability to accept private investments and act as a conduit for individuals to direct donations to their favorite charitable organizations who normally would not be able to accept donations of private investments.

Most individuals make their charitable donations in cash, despite there may being more tax-advantageous ways to give – generally in the form of appreciated securities such as stocks, bonds, and mutual funds. For our clients looking to make charitable gifts we provide recommendations on the best assets to utilize. Increasingly, we have found clients in situations where they have illliquid assets that would be ideal to utilize in gifting.

Tax Advantages of Donating Appreciated Private Stock and the Sale of the Business

In the case of business owners, the utilization of a DAF could make even more sense. Contributing to a DAF can provide an opportunity to maximize the impact of the equity they have worked so hard to build over the years and continue their legacy in the community.

Often, business owners utilize the liquidation of their business as the primary funding vehicle for their retirement.

For those business owners who are also philanthropic, the DAF can provide a unique opportunity to lower the overall tax burden while fulfilling the owner’s charitable desires for years to come. By donating the shares to a DAF, the business owner can achieve two tax advantages – avoid capital gains and receive a maximum tax deduction in the year they sell the business.  Donating shares provides a greater overall charitable tax deduction than donating cash after the sale of the business as illustrated below.

 Cash Donation   Stock Donation
Interest in Business Sold 100% 90%
Interest in Business Donated 0% 10%
Sale Price @ $5M Valuation $5,000,000 $4,500,000
Less: Capital Gains Tax Paid1 $1,190,000 $1,071,000
After Tax Sale Proceeds $3,810,000 $3,429,000
     
Less: Out of Pocket Donation $500,000 $0
Plus: Tax Savings from Donation2 $198,000 $198,000
Net Proceeds After Sale and Donation $3,508,000 $3,627,000
Tax Savings from Stock Donation Before Sale $119,000

1Capital Gains Rate of 23.8%
2Income Tax Rate of 39.6%

Favorable Tax Treatment and Simpler Administration Compared to Private Foundation’s

While a Private Foundation may provide individuals with a sense of prestige and pride, there are a number of restrictions and relative tax disadvantages that make the DAF an appealing option.

Donating the stock to a DAF is also a more attractive alternative than donating the shares directly to a foundation.  When gifting shares to a foundation your deduction is limited to only your cost basis, which as we mentioned earlier, is likely much lower (or possibly non-existent) than the final sale price.  However, if you donate the shares directly to a public charity, or to a DAF, you can claim the full market value as a deduction – and avoid paying taxes on the appreciation.

Another advantage of the DAF is that it qualifies as a public charity, allowing your donation to offset 30% of your Adjusted Gross Income, versus a maximum of 20% of your adjusted gross income if you donate the funds to a private foundation. The tax deduction can be carried forward for a maximum of five years.

Finally, a DAF provides the donor with a much lower burden in terms of administration.  A Private Foundation may be subject to an excise tax of up to 2% of annual investment income and requires a 5% distribution annually – both of which are avoided by the DAF.  From an administrative standpoint the DAF eliminates the recordkeeping, disclosures, tax filings, and legal documentation that come with setting up a Private Foundation.

So, how does this all work?

While the DAF is a simple and flexible method to set up a charitable legacy, donating privately held stock is a more complex process than donating public stock.  The major hurdle is that the DAF will generally require a valuation of the business.  That valuation will determine the funding amount of the DAF as well as your charitable deduction.  It is also important that the clients’ attorney and tax advisers are involved in the process to avoid any missteps that may inhibit the operations of the company or the potential tax savings from the plan.  For instance, if the donation occurs after an agreement of sale has been reached the donation may violate the Internal Revenue Service’s anticipatory assignment of income rules or if the asset is depreciated, depreciation recapture may occur. In either of these instances, the deductible portion of the donation may be limited.

The DAF can and should be funded prior to the sale of the business and the stock will remain in the DAF until the liquidating event.  Upon liquidation, the donor remains in control of the funds and has the flexibility to donate all funds at once or to donate funds as they see fit over a number of years.  Depending on the time horizon of the anticipated grants, the donor may choose to invest the assets in a diversified investment strategy or keep the funds in a money market if they expect gifts to be made over the short-term.

Overall, the DAF provides an attractive option for business owners to limit taxes and maximize the overall charitable impact they can have during their life.  We find that most business owners have close ties to the communities in which they built their business and/or are passionate about helping causes close to the business. The DAF is a great strategy to help business owners continue the legacy they have created in their communities beyond the life of their business.

For more information about utilizing your business to help to maximize your charitable legacy, do not hesitate to contact your Wealth Advisor.

Important Disclosure Information

Please remember to contact RegentAtlantic if there are any changes in your personal or financial situation or investment objectives for the purpose of reviewing our previous recommendations and services, or if you wish to impose, add, or modify any reasonable restrictions to our investment management services. A copy of our current written disclosure statement discussing our advisory services and fees is available for your review upon request. This article is not a substitute for personalized advice from RegentAtlantic. This article is current only as of the date on which it was sent. The statements and opinions expressed are, however, subject to change without notice based on market and other conditions and may differ from opinions expressed in other businesses and activities of RegentAtlantic. Descriptions of RegentAtlantic’s process and strategies are based on general practice and we may make exceptions in specific cases.

Please remember that RegentAtlantic does not provide tax or legal advice.  Please remember to speak with a tax and/or legal professional of your choosing prior to implementing any of the strategies discussed in this article.