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Sunday, April 28, 2024
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Case Studies |
S Corporation Gifts - Strategies and Hurdles Every Advisor Should Know, Part 2 - A Thorny Gift Even in Charity's Tax Exempt Hands
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Case:
Tommy Ely, 58, owns and operates eight car dealerships spread throughout the city and surrounding areas. Founded in 1977, Tommy is the sole shareholder of Ely Motorsports, Inc., an S corporation. The eight car dealerships represent mainly high-end, luxury car lines. Specializing in providing unparalleled customer service before, during and after the sale, Ely Motorsports appeals to the affluent and wealthy. Not surprisingly, Ely Motorsports generates over $250 million annually in sales and consistently ranks among the nation's top five best dealerships, a record 12 years in a row.
As a long-time active member of the community, Tommy is frequently invited to charity fundraisers and events. Tommy is also one of the top ten richest people in the city, which probably does not hurt his popularity either. At a recent fundraising function for at-risk youth, Tommy publicly pledged $1 million for the building of a recreational youth facility. Tommy is constantly supporting at-risk youth programs in the local community. The at-risk center is a public charity described in Section 501(c)(3) of the Code.
In fact, Tommy was an at-risk youth himself. Having run away from an abusive home at age fifteen, Tommy actually lived on the streets for a brief time. Fortunately, Tommy was befriended and taken in by volunteers of the local at-risk youth center at the age of sixteen. Through love, support and counseling, Tommy turned his life around and the rest is "car" history. Consequently, the $1 million pledge announcement and lifetime support of at-risk programs was not a surprise to the people who know Tommy's story.
Question:
Tommy wants to satisfy his $1 million pledge obligation with a gift of approximately 1,000 Ely Motorsports shares. What are the tax consequences to a public charity that receives S corporation stock? Should they refuse or accept Tommy's gift?
Solution:
Prior to 1998 a Section 501(c)(3) charity could not be an S corporation shareholder. Thus, donors could not contribute S corporation stock to charities without adversely affecting the corporation's tax status. However, commencing January 1, 1998, the Code was amended to permit a Section 501(c)(3) charity to be a shareholder of an S corporation. That is the good news. But there also is some not-so-good news.
Tax consequences to charity: One of the major tax benefits of being a 501(c)(3) organization is being exempt from federal income taxes. However, a 501(c)(3) organization is subject to income tax on its unrelated business income (UBI). Therefore, it is important for charities to avoid activities and investments that would be subject to UBI tax.
With respect to S corporation stock, Section 512(e) states that if a Sec. 501(c)(3) holds S corporation stock, any income or gain from such holdings will be UBI. In other words, a charity will pay tax on any income distributions it receives while holding the stock and pay tax on any gains it realizes as a result of a sale of the stock. The income would be subject to corporate or trust tax rates depending on the charity's organizational structure. Since charity must pay tax on any income or gains, a charity would naturally realize less than the fair market value of the stock on the date of transfer.
Because Tommy wants to make a gift of $1 million, he realizes he must take into account the UBI issue. After discussions with Tommy's and the charity's accountants, Tommy contributes $1.4 million of Ely Motorsports shares to the at-risk youth center. After taking into account the tax liability, the at-risk youth center should net $1 million from the gift.
In the end, Tommy satisfies his $1 million pledge with a gift of 1,400 Ely Motorsports shares. Happily and enthusiastically, the at-risk youth center breaks ground on the new recreational facility - Ely Recreational Center - by month's end.
Editor's note: There are many non-tax issues that charity must consider before accepting a gift of S corporation stock. Most importantly, a charity must identify who will purchase the stock once it is a stockholder. Because there is usually a very limited market for S corporation stock, a charity may end holding the stock for a long period of time. Thus, it is essential to identify potential buyers of the stock prior to receipt. In many instances, the S corporation will redeem the shares or another unrelated shareholder will purchase the shares from charity. However, it is vital that donors not engage in a prearranged sale. For more information on prearranged sales, see GiftLaw Pro Chapter 5.5.1.
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