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.
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:
- 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”.
- 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
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