S2, E3: Donating complex assets: Business interests

This is the third of six episodes in our second Philanthropic Insights series that offers advisors everything they need to know about making the most with gifts of complex assets. Throughout this series, we will discuss the various areas of complex assets such as real estate, business interest, passion assets, alternative investments, and qualified appraisals – and we will bring in top experts in these fields. 

Kim is joined by her co-host and fellow expert on complex assets, Katie Collin, Complex Gift and Grant Director at Ren, and in this episode, they discuss gifts of business interest.

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Until next time, keep giving wisely.

Transcript

Kim Ledger:

Welcome to Ren's Philanthropic Insights video podcast series made to help financial advisors make the most of their client's charitable giving. I'm your host, Kim Ledger, Ren's VP of Complex Assets. In this series, we are sharing everything you need to know about making the most with gifts of complex assets.

Throughout the series, we are discussing multiple areas of complex assets like real estate, business interests, passion assets, alternative investments, and qualified appraisals, and we're bringing in the top experts in these fields.

With me today is my co-host and fellow expert on complex assets, Katie Collin. Katie is the complex gift and grant director here at Ren, and today we're talking about gifts of business interests, one of my favorite topics. Katie, thanks for joining me.

Katie Collin:

Kim, I'm thrilled to be back. Thanks for having me.

Kim Ledger:

Yeah. Yeah, we're in episode three now of season two-

Katie Collin:

Love it.

Kim Ledger:

... and we've had a couple of other good... We had the intro and then we've talked about real estate, so today is one that I think will be pretty popular. A lot of advisors will have questions about this, because this is kind our bread and butter, what we see day in and day out-

Katie Collin:

Right.

Kim Ledger:

... our business interests. So let's talk about, again, set the stage about defining what is a business interest?

Katie Collin:

Right. So, we really can talk about a lot of different things here. I think the most common ones you and I probably see are C corporations, S corporations, LLCs, some limited partnerships, and so we're really looking at are you running a business? Do you have a solo proprietorship? What are you doing? What are you making? Are you an entrepreneur? How does this potentially impact your charitable giving, and can this be the right asset to use?

Kim Ledger:

Yeah, 'cause we'll work with people who are investors, the founder, often we work with the founder or co-founder or one of the executives that holds the private shares. So I think that's probably a good distinction too, is that it tends to be shares of a privately held company.

Katie Collin:

Yes. Yeah, good distinction.

Kim Ledger:

Yeah. So, you mentioned the different entity types. How do those impact your charitable donation?

Katie Collin:

Yeah, so that's really what we've talked about before, bringing in the professionals around the donor to help understand what do they own. I know you and I've had some conversations with individuals and they're like, "Well, I don't know what kind of company I have." Okay, well, let's picture, right.

Kim Ledger:

LLCs tend to trip people up-

Katie Collin:

They really do.

Kim Ledger:

... because LLCs can be taxed in a variety of ways.

Katie Collin:

Right, as a partnership.

Kim Ledger:

Yeah. Is an LLC, as a partner, I'd say the majority of taxes are partnership, but not all. They can be taxes in C corporation and some even elect to be taxed a C corporation. So that's important to know. It's like the answer is not just LLC, it's LLC taxed as a-

Katie Collin:

Fill in the blank.

Kim Ledger:

Because each of those different business entities is taxed. There's a tax implication to the donor advised funds. Can you speak to that?

Katie Collin:

Right, There is. So just because the donor advised fund is a tax-exempt entity does not mean that there's no tax that will flow through if a gift is made. So the unrelated business tax is really the one that we're concerned about. Where's that going to hit? How much of that income is going to be generated? And so we do really want to make sure that when we're talking with the donor and the advisors they're working with to think through this, there may still be tax. You do need to keep enough liquidity in your donor-advised fund to account for that, especially with S corporations and how those can be taxed at the state level as well. We really have to be careful and have a thoughtful conversation around, yes, you're going to make a gift, yes, you're going to qualify for a charitable deduction. However, you have to remember there's still some tax associated with this. And how does that then affect you and your team around you making your plan going forward.

Kim Ledger:

And the tax being the tax to the donor advisement?

Katie Collin:

Correct, correct.

Kim Ledger:

So the donor gets the charitable deduction based on-

Katie Collin:

Charitable deduction based on the type of gift that they are making and the tax consequences then inside the donor-advised fund.

Kim Ledger:

But what determines the value of their gift is the qualified appraisal.

Katie Collin:

Yes.

Kim Ledger:

Which is why we're going to have those guys here for-

Katie Collin:

Very excited to have them on later.

Kim Ledger:

... episode six, to talk about that. We get lots of questions about qualified appraisals. And that's really between the donor and the IRS. That's part of their tax return preparation.

Katie Collin:

Exactly.

Kim Ledger:

So while we need a copy of it for our records, it's really between the donor and the IRS.

Katie Collin:

That's correct.

Kim Ledger:

That is what substantiates the charitable deduction.

Katie Collin:

Exactly, exactly.

Kim Ledger:

Yeah, that's what I was getting to. Yeah. Good. So the business interest, so when you're talking about the tax to the donor-advised fund S Corps are a little different in that we have, I think it's the only entity where the DAF has to pay income tax or unrelated business income tax on the capital gains in addition to any income that's attributed to the DAF. So that's different than where we get just downright giddy with a C corp because-

Katie Collin:

Right, there isn't any tax. There isn't any. And it really does, it makes everything easier. And I think because people aren't always thinking, oh, there could be tax associated with this that the DAF will have to pay. It's just a thing that I know you and I try and make sure we bring up so that people are prepared.

Kim Ledger:

Right. They aren't caught off guard on it. It does not keep you from making the gift.

Katie Collin:

No, it does not.

Kim Ledger:

It just says you need to be aware.

Katie Collin:

Be aware of it, be aware.

Kim Ledger:

So as we look at gifts of complex assets, what are some of the challenges that we often have to overcome? And they're certainly not insurmountable.

Katie Collin:

Right.

Kim Ledger:

The variety. When you own a business, you're very careful about who comes in and who's going to be a shareholder. And the donor advised fund is going to be really careful about, they're going to become a shareholder, so they want to do their due diligence as well. So as you are reviewing documents when that gift is being made, what are some of the things that you tend to find that we have to overcome?

Katie Collin:

Right, so we're really looking for the, as you said, you're inviting the donor advised fund to be a shareholder in this entity up until there's a liquidity event in most cases or some sort of redemption event. And so what does that mean for the DAF being the shareholder? So we're looking at can it be transferred? Because sometimes that's a hurdle to get through. The documents don't contemplate transfers. And so that's one of the things that we look for going through those documents. Can you transfer it? Because some companies are written, you can only transfer it to a family member or a trust for the family member. So it would be asking if the general counsel can be involved, asking if the board needs to be involved. Can there be some sort of waiver granted for this transfer? Can your documents be amended to allow for transfer?

The other thing we're looking for as we're going through these documents are what responsibilities would the DAF have if it were to be a shareholder? Are there votes that have to happen? Are there events that have to happen that the DAF would have to participate in in some way? And the other piece we're looking for too is timing. A lot of business interest gifts, depending on the timing of when it is happening during a calendar year, there can be blackout dates for certain things.

So we're really looking to figure out can we make the transfer? What responsibilities will the DAF have to accommodate, and the timing factors. And really looking for the, do we have enough time to get it done or, are we at a point where we might not be able to get it done right now, but because now we've done all this due diligence and we've gone through this process, can we plan to do it next quarter? Can we plan to do it in two quarters so that we're really have everybody-

Kim Ledger:

If everybody gets the window.

Katie Collin:

Right, everybody on the same page.

Kim Ledger:

And as soon as someone begins to go through a transaction, I always encourage people to get through that due diligence process so that that's not a holdup at any point during the process.

Katie Collin:

Right.

Kim Ledger:

Let's get that done. And then when everybody's ready to make the gift, then we're good to go.

Katie Collin:

Exactly.

Kim Ledger:

One of the things that you mentioned was voting rights.

Katie Collin:

Mm-hmm.

Kim Ledger:

So I often get questions about that. Well, can I keep the voting or does that have to go with the stock?

Katie Collin:

Right, and it really depends on, we have to look at the whole context of the situation. I think in the majority of cases, should the DAF be a voting shareholder? Probably not. And to avoid that if you can.

Kim Ledger:

But if the donor has those voting rights, it has to follow the stock.

Katie Collin:

It has to follow the stock. And I know we've also worked in transactions where we are working with the donor, the board, the general counsel. There are times when that voting stock can transition to non-voting stock and then the individual can make the gift. So again, it's putting up that context together, thinking through the timing and figuring out when's the right time to make this gift and can the company accommodate the fact that the DAF is the shareholder.

Kim Ledger:

Yeah. I've had just a few where we were unable to, the transfer restrictions don't tend to be a huge hurdle to get through, but occasionally they are. And occasionally, and I would say maybe two or three gifts that I've worked on where we just haven't been able to get through that.

Katie Collin:

Right.

Kim Ledger:

But for the most part, it's not a difficult challenge to overcome.

Katie Collin:

I think when we keep those lines of communication open, when the general counsel of the company, when the board of the company is engaged and wants to help this individual make the gift, there are solutions.

Kim Ledger:

Yeah, exactly.

Katie Collin:

There are solutions.

Kim Ledger:

And they get excited. And often what happens is that somebody else will say, "Well, I want to do that." Exactly. And you start with one person and you may end up completing four gifts

Katie Collin:

Right, or five.

Kim Ledger:

Yeah.

Katie Collin:

You never know.

Kim Ledger:

It's exciting.

Katie Collin:

We just did that.

Kim Ledger:

Yes. So why would a business owner make a gift of their business prior, I mean, they're going through the transaction and I'm keep using that as an example. There are other times that we do where donors make gifts of business interest where there's not an immediate transaction. But right now, let's just talk about that piece of it. So they're going through a transaction because it's a hectic time.

Katie Collin:

Right.

Kim Ledger:

There's a lot going on. There are a lot of requests for information.

Katie Collin:

Right.

Kim Ledger:

We're going to ask for information. We're likely going to have some questions. So why go through this?

Katie Collin:

Right, well, the first part is charitable deduction-

Kim Ledger:

Yes.

Katie Collin:

... but the second piece that's really important in these scenarios is capital gains tax.

Kim Ledger:

Yeah.

Katie Collin:

So really the capital gains tax is eliminated for the most part when you are doing a gift in advance of some sort of sale transaction, liquidity event. And it's really, it is a great way for the individual to save on their taxes-

Kim Ledger:

Yeah.

Katie Collin:

... but if they have this passion for being charitable, you're getting two for the price of one. So if there's a way to make it happen, this really is the best solution. There have been times when I've been on calls with individuals in their advisor and things are moving very fast. And that is one thing I want to make sure these potential donors are aware of. If this is too much, we don't have to do it this way, or we can push pause for this if you know there's going to be a secondary transaction. But if you can be in it for the long haul, which is really usually just a few weeks of hectic, this is such a great way-

Kim Ledger:

It really is.

Katie Collin:

... to be able to participate.

Kim Ledger:

So who needs to be involved? So obviously you need the people from the complex asset, group at the donor of advice fund, which is us-

Katie Collin:

Right, right. And we're super excited and we can help build that table with the donor and their input. So we're looking to see who's helping you with financial planning, who's helping you with tax planning, and who's helping you with your estate planning. All of these pieces have to go together. And sometimes it will be financial planning and your investment advisor, because what are we going to do with the cash that's generated from the sale? Because yes, you're donating a piece of it, but there's also going to be some for you as an individual. So it's really putting all those people together to make sure that the best outcome is happening.

Kim Ledger:

Yeah, and it's not unusual to have the general counsel or the CFO from the company on those calls as well. Sometimes it looks a little bit like the old Hollywood Squares game, you've got the nine people on squares across on the screen. But I love that because everybody is working towards the same goal in the most efficient way possible, and there are no surprises.

Katie Collin:

Right, and then when the general counsel's on board from the beginning, if you do have to adjust documents or draft any sort of waiver, I've done that. You've done that. You work behind the scenes with the general counsel getting all of that approved so then it can get to the board right away, and then everybody can sign in advance.

Kim Ledger:

Yes, and I've worked with some engineering firms that where we've had to make changes to the documents, and it's taken a long time because it's significant shift for the company to allow someone besides an employee to be an owner and to understand that they can't force the DAF to sell it.

Katie Collin:

Right.

Kim Ledger:

So let's talk about assignment of income.

Katie Collin:

Oh, assignment of income.

Kim Ledger:

Yeah. When I say assignment of income, what do I mean by that?

Katie Collin:

So we really want to be careful of how is this transaction happening, timing of this transaction happening. Because if we are too far along in the process, are you then in jeopardy of not being able to get your charitable deduction? Are you at that point in the sale transaction where is it so far along that it's so predetermined, you can't unwind from it. It's more likely than not. And I think I'm not remembering the right word there, but so certain to happen,

Kim Ledger:

All but certain to occur.

Katie Collin:

Yes, yes.

Kim Ledger:

There it is. I use that phrase on a daily basis.

Katie Collin:

Yes. Such that you can't, like I said, you can't really unwind from it at that point. So you're going to run up against IRS rules, case law that says this isn't allowed.

Kim Ledger:

Yeah, it's too far along. You're signing income that should be coming to you. So there needs to still be some points of negotiation in the deal. And once it's all set, you're done. You're too late.

Katie Collin:

And I've had that happen, unfortunately, where someone has come forward and said, okay, purchase agreement is signed. I'm ready to make my gift and save my capital gains tax. And I said, we really need to have you step back and talk to your tax professional, because this seems like it would be too far along that you've passed the point of no return. You are really in jeopardy of an assignment of income and you need to take a step back. And then when I've reached out in a couple of weeks, they're like, you were right.

Kim Ledger:

Well, and that's a really good point too, is that I'm not going to make a recommendation on that. You're not going to, the financial advisor's, not going to, the donor needs to work with their tax professional, their tax advisor on the timing of the gift.

Again, like the qualified appraisal that's between you and the IRS, it doesn't affect the charity, but it is important to get that tax advice.

Katie Collin:

And we want to help them be aware that these things come into play-

Kim Ledger:

Exactly.

Katie Collin:

... but we can't give specific legal and tax advice.

Kim Ledger:

Does the IRS put any limitations to the donor advice fund? I know donor advice funds, obviously the whole goal of a donor advice fund. We talked about this in our first episode about the need for liquidity. So that's what we're looking forward to. But does the IRS force that as well?

Katie Collin:

Right. So there's nothing on the books right now that says your donor-advised fund has to hold 50% of liquid assets and can only hold 50% in anything alternative.

However, there's a lot of talk about that. I think it's important for people to understand, and because donor-advised funds are there to make grants, a lot of organizations have some sort of guideline in place. We'd love you to make a grant every two years, every three years, if there's a process in place for your charitable giving and you need to, or you have items that are happening such as a sale of a business or other things, or maybe using a passion asset to put funds in your DAF. It's not a black and white rule for most donor-advised funds, but it is something that's being discussed.

It's really important to keep up with legislative updates. It's really important to keep up with your local estate planning council, your local planned giving council and other outlets that might be able to shed light on where this is going. There have been proposals, they just haven't gone anywhere yet.

Kim Ledger:

What about Excess Business Holdings?

Katie Collin:

Oh, excess Business Holdings. Oh, Kim.

Kim Ledger:

Well, we could spend an entire thing on excess business holdings.

Katie Collin:

Exactly.

Kim Ledger:

So let's not even try to get-

Katie Collin:

Too weedy.

Kim Ledger:

Too weedy on this. Let's just add a really high level. Let's talk about excess business holdings. Let's do it. It's a really complex-

Katie Collin:

It is really complex.

Kim Ledger:

And it's like you've got to put your right hand on the top of your head and hold your left leg. And then it's not, I don't know. There are a lot of rules around it. I'm making a little bit of fun of it. But just again, super-

Katie Collin:

High level.

Kim Ledger:

... high level.

Katie Collin:

So it's really important to understand just how much is in the donor advise fund, just how much of a business interest might be held still then by that individual donor, by any of their relating family members.

Kim Ledger:

You're talking about ownership of the business?

Katie Collin:

Yes.

Kim Ledger:

Okay. Not of the interest. Not how much of the DAF is the business, but how much the DAF owns of the business.

Katie Collin:

Yes, yes. Thank you for clarifying there. I want everybody to follow along. So really thinking through this ownership structure, because that's what is going to trigger excess business holding and thinking through, if the gift is made and the DAF only owns 2% or less, you're going to be okay. If the interest is going to sell quickly, you're going to be okay. It's these long-term holds when they're-

Kim Ledger:

Because deals fall through.

Katie Collin:

They do. They do. And you and I talk about it all the time. Worst case scenario.

Kim Ledger:

Right.

Katie Collin:

What happens if this gift of this business interest doesn't go through? How much does the DAF own percentage wise? How much does the original donor, their family members, trusts for themselves or their family members? Because there's a 20% threshold that we're trying not to hit.

Kim Ledger:

And a five year timeframe.

Katie Collin:

And a five year timeframe.

Kim Ledger:

So we just have to make sure that we look at all of that.

Katie Collin:

Right.

Kim Ledger:

So that's just another consideration.

Katie Collin:

Right.

Kim Ledger:

And making sure you have some plan Bs and Cs out there.

Katie Collin:

Exactly.

Kim Ledger:

And there are some.

Katie Collin:

And again, it goes back to the communication that we've talked about before. Let's make sure everybody understands what's going on. So we have our plan B, we have our plan C, and we can make sure if things aren't moving forward the way they're expected, how can we overcome some of that and have a solution ready to go?

Kim Ledger:

Got it. Well, I know we've covered a lot today, and we could probably go on another 30 minutes-

Katie Collin:

Or more.

Kim Ledger:

... but our time is up for the day, and so I appreciate you joining me today, Katie, and discussing business interest gifts.

Katie Collin:

Thank you for having me.

Kim Ledger:

Thanks everyone for watching or if you turned in via podcast, thanks for listening. If you want to learn more about REN and how we might be able to help with your philanthropic program needs, visit reninc.com or email us at consulting@reinc.com.

We'd also love to hear if you have questions or topics about planned giving you want us to talk about.

And of course, don't miss the great information we have in our advisors Philanthropic Insights newsletter. Sign up at reninc.com/advisorinsights.

Find all the links mentioned in the show in the description, and you'll find expert tips daily on our social channels. Check it out. Until next time, I'm Kim Ledger. Give wisely.