A recent Tax Court case affirms the importance of timing and documentation when planning a charitable stock donation before a business sale.
Prior to selling a business, small business owners often consider donating their company stock to charity. If executed correctly, donating stock prior to a business sale may reduce capital gains while allowing owners a charitable contribution deduction.
In Estate of Hoensheid et al. v. Commissioner, (No. 18606-19; T.C. Memo. 2023-34) the Court determined the timeline of events associated with the transfer of stock and subsequent sale of the business resulted in the petitioner significantly underreporting capital gains.
The Court held that by delaying the gift until the transaction was essentially finalized, the petitioner avoided recognition of realized income under the anticipatory assignment of income doctrine. The Court’s decision also highlighted the petitioner’s failure to secure a qualified appraisal given that the stock gift exceeded $500,000.
The Timeline of the Case
In 2014, the petitioner (now deceased) and his two brothers equally owned all the outstanding shares of Commercial Steel Treating Corporation (CSTC). The brothers were grandchildren of the founder. In the fall of 2014, the brothers began to explore a potential sale of CSTC and established a target sale price. On April 1, 2015, a private equity firm submitted a letter of intent to acquire CSTC for a price more than the original target price. On April 23, the brothers signed a nonbinding letter of intent with the buyer. The next month, on May 22, the brothers signed an affidavit indicating their intent to complete the transaction and sell CSTC.
During negotiations, in mid-April, the petitioner expressed to his financial advisors his intent to donate a portion of his CSTC stock to Fidelity Charitable Gift Fund, a tax-exempt, charitable organization with a donor-advised fund program. On June 1, after the terms of the CSTC sale were negotiated and agreed upon, an advisor to the petitioner emailed Fidelity Charitable a letter of understanding describing the planned stock donation. The petitioner sent a donation letter to Fidelity Charitable, which the tax-exempt entity confirmed on June 11. However, the petitioner did not send Fidelity Charitable the CSTC stock certificate at this time.
Over the next month, the terms of the sale were finalized, and the petitioner delivered the CSTC stock certificate to Fidelity Charitable on July 13. The sale of CSTC closed on July 15, 2015.
On his 2015 return, the petitioner reduced the amount of his recognized gain to reflect the stock transfer and took a charitable contribution deduction. The return included a completed Form 8283, Noncash Charitable Contributions, with an attachment titled “CSTC Fidelity Gift Fund Valuation.” The form reported the donation date as June 11, 2015.
Anticipatory Assignment of Income
The anticipatory assignment of income doctrine prevents taxpayers from transferring, or assigning, realized income to another taxpayer before actual receipt to avoid income recognition. The Court determined the petitioner effectively realized income from the CSTC sale before the July 15 closing date because of evidence (including a fixed sales price) supporting that the CSTC sale transaction was virtually certain.
Based on Michigan state law, the petitioner’s resident state, determining the validity of a gift requires three steps:
- donor intent to make the gift
- actual or constructive delivery of the subject matter of the gift
- donee acceptance
The Court concluded that although a valid gift was executed on July 13, 2015, the terms of the CSTC sale were fixed before the stock delivery resulting in an unreported gain on sale of CSTC.
Qualified Appraisal
The Court acknowledged the validity of the gift on July 13, 2015, but denied the charitable contribution deduction. Among other requirements, contributions of property exceeding $500,000 require a qualified appraisal to substantiate the deduction. The petitioner’s gift of CSTC shares was valued at over $3 million dollars in June 2015.
An appraiser signed the completed Form 8283; however, the Court determined the appraisal did not meet the requirements of Internal Revenue Code Section 170(f)(11)(D). Specifically, the Court cited the following: the valuation was not completed for federal income tax purposes; the appraisal included an incorrect date of transfer; the appraisal date was considered premature; the appraisal did not sufficiently describe the method for the valuation; it was not signed by the appraiser; it did not include the appraiser’s qualifications; the appraisal did not describe the property in sufficient detail; and the appraisal did not include an explanation of the specific basis for the valuation.
Important Reminders
This case provides two important reminders. First, the importance of completing charitable gifts of stock prior to selling a business. In this case, the Court determined that the stock transfer (two days before the business sale closing) was made after the sale transaction was agreed upon, essentially eliminating all the petitioner’s risk.
No bright-line rule exists, but donations must occur before finalizing the terms of the business sale, including, for example, signing a letter of intent or other sales contract.
Second, make sure the appraisal conforms to the applicable rules. A review of the rules compared to the components of the appraisal prior to filing the return can save a valuation deduction. There are other important rules to follow as well, including the necessary components of the Form 8283.
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