Friday April 26, 2024

4.14.5 Asset Sale Strategy

Asset Sale Strategy

UBIT Issues:  When an S corporation contributes its assets to a charity or CRT, if the income generated by those assets is not passive income, the charity or CRT will have UBI.

Transfer of "Substantially All" Assets:  If an S corporation chooses to contribute assets to a charity or a CRT, it is important that the S corporation contribute less than substantially all of its assets.

Passive Income Limit:  If the Subchapter S corporation was previously a C corporation and held earnings and profits at the time of the Subchapter S election, then there is a 25% limit on passive income.

Self-Dealing Concerns:  If an S corporation contributes its assets to a CRT, it must avoid self-dealing concerns.

Permanent Charitable Tax Extenders

In December of 2015, both the Senate and House passed the Protecting Americans From Tax Hikes Act of 2015 (H.R. 2029). The bill makes permanent four charitable tax extenders.

The four permanent charitable provisions include the following:

1. Conservation Gift Limits – Gifts of property for conservation purposes benefit from increased deduction limits. The normal 30% limit for appreciated property gifts is increased to 50% and the carry-forward limit is extended from five years to 15 years.

2. Food Inventory Gifts – An enhanced deduction for contributions of "apparently wholesome" food will be available for all donors. The deduction is the lesser of twice the basis or basis plus one-half of the appreciation.

3. IRA Charitable Rollover – Each IRA owner may make a transfer of up to $100,000 per year to a qualified charity. The IRA charitable rollovers are tax-free and not included in adjusted gross income.

4. S Corporation Appreciated Gifts – A Subchapter S corporation may give appreciated stock or land to charity. Only the basis of the S corporation in the donated asset will be used to reduce the shareholder basis, even though the full fair market value deduction is claimed by the shareholder.


Another strategy for avoiding the rules that require charities to pay tax on S corporation income or sale proceeds and that prevent CRTs from owning S corporation stock is the use of an asset sale. Rather than having a shareholder transfer S corporation stock to charity or a term of years CRT, the S corporation itself contributes assets to charity or to a term of years CRT. The S corporation receives a charitable deduction for the gift and this deduction "flows through" to the S corporation shareholders.

Each Sub S shareholder is only able to use the deduction to the extent of his or her basis in his or her S corporation shares. Sec. 1366(d)(1). Subchapter S corporations have both an outside basis in the stock by the shareholder and an inside basis in corporate assets. When gifts of appreciated property are made by the Subchapter S corporation, the deduction flows through to the shareholder. In this case there is an adjustment of the outside basis of the shareholder. Sec. 1367(a)(2). For a gift of appreciated property, the deduction flows through at fair market value, but the decrease in shareholder basis is equal to the adjusted basis of the gifted property to the Subchapter S corporation.

*EDITOR'S NOTE: The tax extenders periodically passed by Congress reduce the outside basis by an amount equal to the adjusted basis in the gifted property and not the value of the deduction. Until Congress acts to extend the rule, the outside basis is reduced by the value of the deduction and not the adjusted basis in the gifted property.

Example 4.14.5

Sally Stewart purchased 50% of the stock of Squishy Inc. for $100,000 ten years ago. Squishy Inc. is an S corporation. Sally and the other shareholders of Squishy, Inc. want charitable income tax deductions but cannot find any charities willing to accept donations of their Squishy stock. Squishy Inc. therefore funds a 20 year CRT with an asset with fair market value of $1,000,000 and cost basis of $200,000.

For its contribution, Squishy Inc. gets a deduction of approximately $300,000 with a prorated basis of $60,000. With 50% of the stock, one-half of the deduction flows through to Sally. She deducts $150,000, and reduces her outside basis in her stock by $30,000. Her remaining basis is then $70,000. The appreciated type deduction is usable to 30% of her adjusted gross income because it consists of long term capital gain property.

UBIT Issues
When an S corporation contributes its assets to a charity or CRT, if the income generated by those assets is not passive income, the charity or CRT will have UBI. See GiftLaw Pro 4.14.7 for a discussion of this concern and the Lease UBI Solution.

Transfer of "Substantially All" Assets
If an S corporation chooses to contribute assets to a charity or a CRT, it is important that the S corporation contribute less than substantially all of its assets. This is because a corporation that transfers all or substantially all of its assets to a charity or a CRT must recognize gain or loss immediately before the transfer as if it had sold the assets for their fair market value. Reg. 1.337(d)-4. In this instance, the benefits of transferring appreciated property to charity - including the bypass of capital gain - are lost and the contribution is treated as though it were one of cash.

Whether a transfer involves "substantially all" of a corporation's assets is determined based upon facts and circumstances. However, the IRS has generally held that the substantially all requirement is satisfied (1) when assets representing at least 90% of the value of the corporation's net assets are transferred or (2) the assets transferred represent at least 70% of the value of gross assets prior to transfer. Sec. 368(a)(1). To avoid the application of the "substantially all" rule conservative counsel limit asset transfers from S corporations to between 50-60% of total S corporation asset value.

Passive Income Limit
If the Subchapter S corporation was previously a C corporation and held earnings and profits at the time of the Subchapter S election, then there is a 25% limit on passive income. Sec. 1375(a)(2). Because the CRT produces passive income, if there are undistributed earnings and profits the Sub S election will be terminated within three years. Sec. 1362(d)(3)(A). If there are earnings and profits, then it will be necessary for the Subchapter S corporation to distribute those prior to funding the CRT. Distribution of earnings and profits will be taxable income to the owner, but the charitable deduction from the CRT may offset that income.

Self-Dealing Concerns
If an S corporation contributes its assets to a CRT, with the goal of selling those assets, potential self-dealing issues arise. See GiftLaw Pro 4.14.8 for a discussion of self-dealing issues involving S corporations.

Case Studies on Asset Sale Strategy

S Corporation Gifts - Strategies and Hurdles Every Advisor Should Know, Part 6 - The Untouchable Donor:   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 7 - The Untouchable Donor's CRT:   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 10 - S Corporation Falls Short At Year-End:   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.

Ducky Don Benefits His Duck Friends:   Donald Holden Ducksworth, III (Ducky Don to friends) was a lifelong outdoorsman. He loved to hunt and fish. Each fall, Ducky Don and his friends would gather for the opening of duck hunting season.

Private Letter Rulings

PLR 200203034 S Corp's Proposed Trust Fails to Qualify as a Charitable Remainder Unitrust:   Husband is the sole shareholder of S corporation. S corporation intends to transfer a block of appreciated stock into a charitable remainder unitrust. The charitable remainder unitrust would pay quarterly to S corporation for the term of 19 years, then would pay to Husband and Wife for the rest of their combined lives.

PLR 9340043 Subchapter S Unitrust:   In PLR 9340043 the taxpayer owned stock in a subchapter S corporation. While a charity is a permissible shareholder of Sub S stock, it is subject to unrelated business taxable income on payments. Since a charitable trust is not a permissible shareholder in the subchapter S corporation under IRC Section 1361, it is not possible to transfer the subchapter S stock into the charitable trust. However, it was deemed permissible to create a unitrust for a term of 20 years.

Related Topics on Asset Sale Strategy

4.14.10  Charitable Tax Deduction:    The value of a shareholder's gifted S corporation stock is based on fair market value reduced by any ordinary income component of the corporation. Fair market value is generally the price that a willing buyer would pay a willing seller.

4.14.7  Lease UBI Solution:    As discussed in GiftLaw Pro 4.14.5, it is common for an S corporation to make a direct gift of one or more assets to charity or to a term of twenty years charitable remainder trust (CRT). When this occurs, it is important to consider whether the gifted asset is used in an active trade or business. If it is, both the income from that asset and any gain or loss from the sale of that asset are subject to unrelated business income (UBI) tax.

4.14.8  Self-Dealing Issues:    A CRT is prohibited from engaging in any direct or indirect transaction with a disqualified person. Sec. 4941.

      Quiz-Basic



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