Gifting Illiquid Assets
Nearly half of U.S. corporations are classified as S-corporations, representing assets of over $3 trillion. However, these assets are illiquid. For many potential donors, illiquid wealth such as these closely held shares(S-corp and C-corp), limited partnerships, limited liability corporations (LLC), real estate, life insurance policies, and other types of retirement assets can be an initial hurdle for charitable gifting.
Some charitable organizations may simply be unwilling to accept such an asset due to their lack of understanding of how to convert it into usable cash. Some donor advised fund administrators may also be unwilling to engage in such illiquid gifts due to a lack of understanding of how to manage the complexity involved. At American Endowment Foundation, we have the experience and ability to map out the process for donors and their financial advisors to achieve the best tax savings available.
An example of how a donor could gift S-corp shares via a donor advised fund is illustrated below:
Step 1: A donor gifts $1 million of S-corp shares (with a cost basis of zero) into Donor Advised Fund (DAF) #1. The donor receives a $1 million tax deduction.
Step 2: DAF #1 sells the S-corp shares and gifts the net proceeds to Donor Advised Fund #2.
Step 3: DAF #1 pays a 20% Unearned Business Income Tax and also receives a 50% charitable deduction. This creates an effective tax rate of 10%. ($1,000,000 - $100,000 (10% effective UBIT) = $900,000)
Step 4: DAF #2 holds the $900,000 and utilizes it based on the donor’s recommendations and timeline.
Although this process seems complex, the tax savings impact is well worth it. Let us compare the tax bite that occurs if the donor went a different route:
Step 1: A donor gifts $1 million of S-corp shares (with a cost basis of zero) to a charity that is willing to accept such a gift. The donor receives a $1 million tax deduction. The charity assumes the donor’s cost basis of zero.
Step 2: The charity sells the S-corp shares for $1 million.
Step 3: On gifts of S-corp shares, most charities must pay a tax (Unrelated Business Income Tax – UBIT) at the corporate income tax rate of 35% on the appreciated shares ($1 Million x 35% = $350,000)
Step 4: The charity keeps $650,000 after taxes ($1,000,000 - $350,000 = $650,000)
By utilizing the DAF process, it is clear the benefit it offers by making a greater amount of the donor’s wealth available for their charitable interests while still retaining the maximum tax deduction available for the donor.
The strategies to handle illiquid assets can be as varied and numerous as the assets themselves. Call us for a consultation and let us discuss your unique circumstances at 1-888-440-4233.