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Sunday, April 28, 2024
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Case Studies |
Not All Tax-Exempt Organizations Are Treated Equally [Under the Code], Part 3 - Bank President Finds Little Return in Stock Gift to Foundation
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Case:
PetCare is a private foundation (PF) whose primary purpose is the prevention of cruelty to animals. PetCare was organized in 1980 and is exempt from federal income taxes under Sec. 501(c)(3) of the Code. PetCare receives most of its financial support from its founders; however, it does do some public fundraising. Specifically, PetCare raises awareness during local social functions by setting up booths and displays. The booths and displays educate and motivate citizens to support PetCare.
John Hopper is the founder of PetCare. He is also President, Founder and CEO of Big City Bank, a $20 million closely held corporation. In 1980, John created PetCare from a portion of his family inheritance. Now John wants to contribute $1 million (about 5,000 shares) of his highly appreciated bank stock to PetCare. His basis in Big City Bank is merely $10 per share, or $50,000. John loves the idea of bypassing the potential capital gains taxes and receiving a hefty charitable income tax deduction as well.
Question:
What are the tax consequences of making a gift of highly appreciated bank stock to a private foundation? How is a gift to a private foundation different from a gift to a public charity? Should John proceed with this current plan or find an alternative plan?
Solution:
Generally, the deduction limit for gifts of appreciated property to public charities is 30% of a donor's adjusted gross income (AGI). A donor may give and deduct up to 30% of his or her AGI in one year. If the donor gives more than the 30% AGI limit, the excess is carried forward and may be deducted over the next five years.
However, as stated above, PetCare is a private foundation. Consequently, PetCare does not fall within the favorable 30% AGI limitations. Instead, gifts of appreciated property to PetCare will be subject to a 20% AGI limit.
In addition to the lowered AGI limitations, most gifts of appreciated property to private foundations are subject to the reduction rules. See Sec. 170(e). In general, a gift of appreciated stock or land to a private foundation generates a deduction equal to the property's cost basis only. However, if the donor gives publicly traded stock to a private foundation, the donor may receive a deduction for the fair market value of the property gifted.
In this case, John's bank stock is not publicly traded. Therefore, the cost basis rule applies. Consequently, John is allowed only a $50,000 deduction for his $1 million gift. In contrast, if John gave the stock to a public charity, he would receive the full $1 million charitable deduction.
Although John preferred to benefit his own foundation, the difference in tax deductions is too great to ignore. Thus, John elects to make the gift to Friends of Animals, a public charity whose purpose is similar to that of PetCare. As a result, John's charitable deduction equals $1 million. John's appreciated property gift is also subject to the more favorable 30% AGI limitation instead of the 20% AGI limitation. As a taxpayer in the top federal and state tax brackets, John may not only avoid all capital gains taxes on the donated stock, but also save more than $350,000 in federal income taxes (35% x $1 million), plus his state tax savings.
In addition, John decides to create a donor advised fund (DAF) with Friends of Animals. With the DAF, John may make recommendations regarding the DAF distributions. Not surprisingly, John loves his dual involvement with his DAF and PetCare. When taking into account the excellent tax benefits, John's giving is full of purpose, achievement and savings.
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