Donations by S Corporations and Shareholders
Appreciated stock is generally one of the best assets that an individual can donate to a charity. Usually the donor can deduct the full value of the stock yet avoid recognizing taxable gain from the stock’s increased value. The tax-exempt charity usually pays no tax on dividend income or on the gain from selling the stock. However, from the perspective of both the donor and the charity there are three “bad things” that happen when S corporation stock is contributed to a charity: (1) the donor’s income tax deduction is usually less than the appraised value of the stock; (2) the charity must pay the unrelated business income tax (UBIT) on its share of all S corporation income; and (3) the charity must pay UBIT on its gain from the sale of the S corporation stock. This is much harsher tax treatment than if the charity had received and sold an ownership interest in an identical closely-held business enterprise that had been organized as a C corporation, a limited liability company or a partnership.
This article examines the relevant laws and optimal tax planning strategies for charitable gifts of S corporation stock. First, the article examines the relevant S corporation laws and tax-exempt organization laws that could have an impact on a contribution of S corporation stock. For example, whereas every charity and every grantor charitable lead trust can own S corporation stock, a charitable remainder trust is prohibited from doing so. Whereas a private foundation and a donor advised fund must generally dispose of donated S corporation stock within five years of receipt, most public charities do not have such a time limit.
Second, the article identifies the best ways to structure a charitable gift under the existing laws. In most cases, both the donor and the charity will be better off if the S corporation makes a charitable contribution of some of its assets compared to a shareholder making a donation of S corporation stock. If there will indeed be a gift of S corporation stock, then the tax burden can usually be reduced if the gift is made to a charitable trust that then sells the stock and contributes the sales proceeds to the ultimate intended charity. Finally, the article contains suggestions for legal reforms that will make the tax treatment of donated S corporation stock more consistent with the treatment of a donated ownership interest in a C corporation, a limited liability company or a partnership.