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Monday, May 6, 2024
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Case Studies |
S Corporation Gifts - Strategies and Hurdles Every Advisor Should Know, Part 6 - The Untouchable Donor
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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. After attending a recent fundraising function for at-risk youth, Tommy personally decided to give approximately $1,000,000 to the local at-risk youth center.
Tommy is constantly supporting at-risk youth programs in the local community. 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 decision to give and the lifetime support of at-risk programs was not a surprise to the people who know Tommy's story.
In determining the best way to fund the $1,000,000 gift, Tommy realizes Ely Motorsports owns the perfect asset -- highly appreciated investment land. Ely Motorsports frequently buys vacant land for potential new car dealership sites. This particular land holding was purchased six years ago for $500,000 and has since doubled in value. However, Ely Motorsports elected not to build upon this site. Therefore, the property was going to be sold which would result in $500,000 in taxable income.
Question:
Can Ely Motorsports transfer the land directly to charity? What are the tax benefits and pitfalls, if any, associated with this outright gift of land by an S corporation?
Solution:
S corporations report income, gains, losses and deductions on the corporation's income tax return. However, these items then "flow through" to the individual S corporation shareholders' income tax return. Therefore, if an S corporation makes a charitable contribution, the deduction eventually flows through to the individual shareholder. In many ways, an outright gift of property by the S corporation to charity (as opposed to a donor's gift of S corporation stock to charity) is the ideal scenario for both donors and charities.
In this instance, if Ely Motorsports transferred the $1 million investment land to charity, then Ely Motorsports would receive a $1 million charitable income tax deduction. Since Tommy is the sole shareholder, the $1 million deduction would flow through onto Tommy's income tax return just as if he had made the gift himself. Accordingly, the deduction would be subject to the applicable AGI limitations for gifts of appreciated property, i.e. 30% AGI limitation with a five-year carry forward.
With a combined federal and state tax rate of nearly 40%, Tommy's $1 million deduction may save almost $400,000. Another benefit is the avoidance of $500,000 of capital gain. After taking into account federal and state income tax rates, Tommy may bypass nearly $100,000 of capital gains tax.
Other excellent advantages of a gift of property from an S corporation (as opposed to a donor's gift of S corporation stock to charity) are no UBI problem for charity and no discount for lack of marketability.
Two potential issues include a deduction limitation and a risk of capital gain recognition. First, under Section 1366(d)(1), the charitable deduction reduces the shareholder's basis in the S corporation stock by the basis to Ely Motorsports of the gift asset. With a basis of 50% of fair market value, there is a basis of $500,000 in the charitable deduction. Because Tommy's basis in Ely Motorsports stock is approximately $2 million, the full $1 million deduction flows through. Therefore, in this instance, the charitable deduction will not be limited. However, Tommy's basis in Ely Motorsports will decrease by the basis of $500,000 for the charitable deduction property. His remaining basis is then $1.5 million.
Second, Reg. 1.337(d)-4 requires recognition of gain at the corporate level if "substantially all" the assets are given to charity or to a charitable remainder trust. "Substantially all" is not specifically defined, but most other tax regulation examples interpret "substantially all" to mean 80% or 85% of assets. Conservative counsel may set the limit at about 65% of assets. Fortunately, Tommy again is in the clear. With a valuation of over one hundred million dollars, the $1 million gift is not even 1% of the corporation's total assets. Therefore, neither of the two potential tax traps apply to Tommy or Ely Motorsports.
With so many positives, Ely Motorsports proceeds with the gift of the investment land. The resulting significant tax savings and substantial gift to the at-risk youth center make this one of Tommy's easiest and best decisions of the year.
Editor's Note: For the tax consequences of an outright gift of S corporation stock, see Part 1 and 2 in this series.
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