Thursday March 28, 2024

4.14.2 Charity as Sub S Shareholder

Charity as Sub S Shareholder

Business Income:  While charities can own S corporation stock, ownership of S corporation stock has some negative consequences.

Selling S Corporation Stock:  There are many non-tax issues that charity must consider before accepting a gift of S corporation stock.

Private Foundation Issues:  A private foundation is a permissible S corporation shareholder.

Charities that are described in Sec. 501(c)(3) and exempt from tax under Sec. 501(a) are permitted to own stock of an S corporation. Sec. 1361(c)(6).

Business Income


While charities can own S corporation stock, ownership of S corporation stock has some negative consequences. Specifically, a charity's entire share of income or loss from an S corporation is unrelated business income ("UBI") that is taxable to the charity even if the income would not be taxable if the charity had earned it directly (i.e. the income were from rents or royalties, etc.). Also, when a charity sells S corporation stock, the gain or loss on the sale is UBI subject to tax. Sec. 512(e).

Example 4.14.2

Unicorn Foundation is a public charity. Ursula Donor gave Unicorn Foundation shares of Umbrellas Ltd., an S corporation. Ursula's shares of Umbrellas Ltd. were worth $100,000 and her outside basis in those shares was $10,000. Historically, Umbrellas Ltd. stock pays a 10% dividend each year.

Even though Unicorn Foundation is exempt from taxation and generally does not pay tax on its earnings, Unicorn Foundation will pay tax on its share of income or loss from Umbrellas Ltd., because that income or loss is UBI. For example, if the Umbrellas Ltd. stock pays a 10% dividend of $10,000, Unicorn Foundation must pay tax on this income. This is true even though the Unicorn Foundation generally does not have to pay tax on passive income like dividends.

When Unicorn Foundation sells its shares of Umbrellas Ltd., the proceeds of that sale also will be subject to tax as UBI. When Ursula gave her Umbrellas Ltd. stock to Unicorn Foundation, her $10,000 basis in the stock was transferred to Unicorn Foundation. Unicorn Foundation's inside basis in the stock is therefore $10,000 and if the stock is sold for $100,000, Unicorn Foundation must report $90,000 of taxable gain on the sale.

To avoid receipt of UBI, some charities and donors explore whether or not an S corporation can convert to a C corporation before they receive its stock from a donor. If conversion is possible, any gift of the stock is subject to the general rules governing C corporations discussed in GiftLaw Pro 4.12. Conversion to a C corporation is discussed in greater detail in GiftLaw Pro 4.14.6.

Selling S Corporation Stock


There are many non-tax issues that charity must consider before accepting a gift of S corporation stock. Most importantly, and assuming the charity does not want to retain ownership of the stock, it must determine whether it will be able to sell the stock. Typically, a charity either sells S corporation stock to a third-party purchaser or back to the S corporation in a redemption.

Because there is usually a very limited market for S corporation stock, a substantial period of time may pass before a sale or redemption is possible. If a charity identifies a potential buyer or redemption option before the gift of S corporation stock occurs, prearranged sale prohibitions prevent the donor from entering into any binding agreement for sale or redemption. For more information on prearranged sales, see GiftLaw Pro 5.5.1.

Private Foundation Issues


A private foundation is a permissible S corporation shareholder. The same UBI concerns that face all charities that own S corporation stock face private foundations. In addition, private foundations must address the issue of excess business holdings.

In general, a private foundation and its disqualified persons may not own more than 20% of the outstanding voting stock of a company. Sec. 4943. If they do, an excise tax of 10% of the excess business holding is imposed and if corrective action is not taken that excise tax jumps to 200% of the excess business holding.

Often, a donor who contributes S corporation stock to a private foundation owns a substantial amount of the corporation's voting stock. In this case, the excess business holdings rules will be triggered. Any gift of S corporation stock to a private foundation should only occur following analysis by legal counsel as to whether the gift will cause the private foundation to have excess business holdings.

Case Studies on Charity as Sub S Shareholder

Death and Taxes - The Madison Era of Giving, Part 3 of 7:   George Madison, Jr., has definitely become a gift-making machine. Just in the past three months he has gifted $5 million to public charities. George's "ease" into retirement is turning out to be much more exciting than he had ever imagined. Due to the publicity of his two large charitable contributions, George has risen to the top of many gift planners' "people to call upon" list. One such list belongs to Eleanor Jacob, director of development at Education is Power schools. Eleanor consequently called George and asked if she could visit with him. After several visits and trips to the schools, George and Eleanor developed a good relationship. George liked the school's mission and felt he could contribute greatly to its further development. Therefore, George happily pledged a gift of $1 million to help Education is Power upgrade its classrooms and purchase new books for its students.

S Corporation Gifts - Strategies and Hurdles Every Advisor Should Know, Part 2 - A Thorny Gift Even in Charity's Tax Exempt Hands:   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.

S Corporation Gifts - Strategies and Hurdles Every Advisor Should Know, Part 11 - Center's Pooled Income Fund Does An "About Face":   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.

S Corporation Gifts - Strategies and Hurdles Every Advisor Should Know, Part 12 - Family Foundation Gets Behind the Wheel:   Tommy Ely, 58, owns and operates eight car dealerships spread throughout the city and surrounding areas. Tommy is the sole shareholder of Ely Motorsports, Inc., an S corporation founded in 1977. The eight car dealerships represent mainly high-end, luxury car lines.

George's "Green" Sub S Gift On Hold:   George Green was a man of humble beginnings. He was born in Bulgaria and lived with his parents on their farm. But George was a diligent student and was determined to become a successful business owner. After high school he obtained permission to come to America to go to college.

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