Thoughts on startups by investors that
fund them & entrepreneurs that run them

Sideways Startups: Donating Private Stock

Typically, Americans give cash when it comes to charitable contributions. However, for investors and founders, it may be helpful to think outside the box when it comes to giving.

Donations of private stock enable investors, founders and employees to support charitable causes and contribute to the community while receiving simultaneous benefits in the form of substantial cash savings from reduced taxes as well as bypassing capital gains taxes.  In some cases, this can represent a form of “partial liquidity” for otherwise illiquid stock. Donations of private company stock may be an effective and tax-efficient method of giving with significant benefits to the donor. These assets often have a relatively low cost basis (e.g. original cost) – and in the cases of entrepreneurs who have founded companies, the cost basis is effectively zero – and a significant current market value that would result in large capital gains taxes if sold. When such an asset is donated to a public charity in the correct way, the donor not only minimizes capital gains exposure but is also entitled to claim a tax deduction of the full market value (and not just the original cost basis). This tax treatment offers significant benefits at the federal level, and frequently at the state and local levels as well.

The Tax Benefit
At a simple level, you can deduct up to 30% of your annual adjusted gross income for the value of a stock donation. If the value of the donation is higher than this limit, you can continue to deduct the value of the stock donation for an additional five years against your annual adjusted gross income.

An Example
Assume a donor has a gross income of $300,000 per year for the next six years and has a $600,000 fair market value assessment in private stock. They can deduct $90,000 per year from taxable income (30% of $300,000) each year for six years, for a total of $540,000 over six years.  Assuming a marginal tax rate of 45% (federal + state) this would result in total tax savings of $243,000 over six years.

Some Basic Rules

  • Donations must be to an IRS recognized charity
  • Deductions are against ordinary income
  • Deductions beyond the annual limit carry forward 5 years
  • To qualify for a deduction, the donation must be accompanied by an independent valuation appraisal

Why You May Not Have Heard About It

Private stock donations have languished despite enormous private company wealth for a few reasons:

  1. Few charities accept private stock donations

Many non-profit organizations, being primarily mission-focused, are not well equipped to handle this type of contribution and thus might require the donor to liquidate the stock first. This is not always feasible or advisable in the case of private stock, and it also reduces the amount contributed (as the donor would need to pay tax upon sale of the stock).  Furthermore, while some charitable organizations might have some limited experience in handling contributions of complex assets, the cost to the charity to outsource the compliance and liquidation work can be considerable – significantly reducing the net result to the charity.

Some donors also consider creating a private foundation or donating to other private foundations. However, in these cases you are limited to the “cost basis” (e.g. in many cases your purchase price) for deduction purposes, rather than current market value. These donations are also further complicated by IRS rules related to “self-dealing”, “jeopardizing investments” and “excess business holdings”.

  1. Donors lack the time and resources to navigate the process

These challenges can include finding the right charity, time to facilitate the internal transfer process as well as retaining a valuation or tax expert to confirm tax savings and optimize the donation amount.  Finally, the cost of a valuation appraisal required for these donations has historically been very expensive (e.g. in excess of $25,000).

Donating stock often allows donors to make a bigger philanthropic impact and enjoy greater tax advantages than donating cash or selling the stock and donating the proceeds.  By donating securities, you bypass capital gains tax and may deduct the fair market value of your gift.

Frequently Asked Questions:

Q: Why would a company’s board or future investors approve of a donation of stock?

A: The board and investors will likely recognize that reputation for community involvement enhances a company’s culture and standing-at-large, which in turn will facilitate recruiting and retention.

Q: Wouldn’t a contribution of early-stage company stock have a very small impact?

A: No. In fact, the contribution of early-stage company stock can have tremendous impact. Take an example where you donate 25,000 shares of common stock with a value of $0.20 per share. If that company is later sold for $5 per share, the gain can benefit the charity significantly.

Q: How does the tax deduction work?

A: If you donate shares of stock, you take a tax deduction at the time of the donation equivalent to the fair market value of the stock at the time of the donation.

However, if you donate stock options or warrants, you get a tax deduction when the stock options or warrants are exercised. The tax deduction is calculated by taking the “spread” on the date of exercise of the stock option or warrant – the fair market value of the shares at the time of exercise less their exercise price.

Written by Guest Author

user Guest Author

prev next

You might also be interested in

How to Give Women the Wings of an Angel

Canada has not tapped its female angel investor potential – yet.

The female angel investor conversation has been discussed inside and out. From TechCrunch, BetaKit to the Financial Post, there have been more than a few arguments made about the lack of female representation in Canada’s early-stage investment community and the benefits of tapping into this financial resource.

For example,

Read more >

Challenges and Rewards for Angel Investors

One of the most common questions we get is: What are the biggest challenges and rewards of angel investing? High net worth individuals become angel investors for a number of reasons, but the opportunity to work with entrepreneurs and provide guidance to founders is typically high on the list. In this video, angel investor Chenoa Farnsworth explains why, interestingly, both the biggest

Read more >

Measuring the Immeasurable: Evaluating Startups Qualitatively

At Hyde Park Angels, we evaluate startups based on quantifiable metrics related to traction, market size, and more.  But that’s not all we consider. In fact, sometimes the most important factors in determining whether we should invest are qualitative. While these can vary from deal to deal, there are a few that remain the same.

Understanding of

Read more >

Why Does Startup Pricing Vary by Location?

Entrepreneurs seem genuinely surprised to find that investors in Peoria or Little Rock are not willing to invest in startup companies at Silicon Valley prices.  After all, they just read in TechCrunch that investors funded a company similar to theirs at an $8 million pre-money valuation!

The valuation of startup companies shouldn’t be impacted by location, should they?  Guess again! 

Read more >

US Crowdfunding in 2014

Crowdfunding is the practice of raising money for a project or venture from a large number of people utilizing an Internet website or platform.  Funding from each individual can be quite small, $10 or less, although some projects have much higher minimums.  Projects include films, musical recordings, new companies, products, inventions, personal causes and many others.

Since the

Read more >

Comments