Maximizing Business Equity for Impact

It’s likely that some of your best clients are successful business owners who are planning to exit or sell their business in the near future and thus preparing for a major income event (i.e. a major taxable event). These clients have an opportunity to deploy some of their hard-earned equity to make a significant charitable investment in the causes they care about. For you, as a trusted advisor, this presents a great opportunity to enhance your reputation with your clients because of thoughtful and creative planning.

Let’s look at an example: Dan and Diana Digital started a software development business from scratch in their basement ten years ago. The business has experienced tremendous growth and recently a major software company has made a lucrative offer to acquire the Digitals’ business. Dan and Diana will likely accept the offer, and with the advice of their professional advisors, they understand the need for serious estate and tax planning in anticipation of their financial windfall because of the acquisition.

The Digitals are excited about the opportunity to retire early and create a safety net for their children, including their daughter who was born with a serious congenital heart defect. Also, with their newfound wealth, Dan and Diana want to help other kids similarly impacted by congenital heart problems by funding research at the American Heart Association. Fortunately, the Digitals learned from their professional advisors that they could make a larger charitable gift than previously thought, plus enhanced tax savings, by donating a portion of equity in the business prior to the sale versus making a cash gift after the sale.

The Digitals’ estate planning attorney, financial advisor, and CPA coordinated their services so that the Digitals were fully advised of the legal and tax requirements for this specific type of donation as well as the impact on their individual financial circumstances. Specifically, the Digitals learned that by donating some shares in their business prior to sale (versus donating after tax cash proceeds of sale) that they could make a bigger gift and receive better tax benefits like:

• Avoiding up to 100% of the capital gains tax that would otherwise be due if the shares are instead sold thus providing significant income tax savings especially since the Digitals have nearly zero cost basis in their business meaning high capital gains tax exposure.


• Receiving an income tax charitable deduction for the appraised fair market value* of the shares thus helping to offset capital gains taxes resulting from the sale.
  *It’s crucial that the gift value is substantiated pursuant to an independent qualified appraisal made by a qualified appraiser. The appraisal must meet specific requirements and factor in applicable valuation discounts for lack of control and marketability.


• Removal of the donated shares from their estate thus lowering the value of their estate below the federal and state estate tax exclusion thresholds.

The team of advisors worked closely with the Association’s gift planning officer, recognizing that the Association, as a potential new shareholder, must conduct it’s “due diligence” on the gift to review the risks and benefits of accepting the closely held shares. If the Association accepts the shares, it will have sole discretion to sell or keep the shares. If the Association sells alongside the Digitals, the Association will receive tax-free cash proceeds, maximizing the value of the Digitals’ equity gift and enhancing the impact for cardiovascular research. Most importantly, the advisors made sure to inform the Digitals that any donation of shares must occur before the business acquisition is considered a legally binding sale or “practically certain to occur,” in which case the IRS could apply the assignment of income doctrine and deem the donation as a taxable gift.

Determining if a business sale is binding or practically certain to occur is a fact sensitive analysis with multiple factors, but generally the advisors should ask their clients and themselves:

• Is there a signed and legally binding purchase and sale agreement or offer letters that could be construed as such? If so, have most of the contract terms and conditions been fulfilled?


• Do any press releases exist about the planned sale/acquisition?


• If so, then it’s likely too late in the sale process for the clients to donate shares because the IRS could deem the gift as a “pre-arranged sale” and therefore a taxable donation thus defeating the purpose of this gift strategy – something you would not want for any client.

During the Association’s gift acceptance process, it reviews the business financials, legal structure, shareholder restrictions, public relations aspects, and other characteristics to understand its risks and exposure to liability including potential tax liability called unrelated business income tax (UBIT). In doing so, the Association must determine if the Digitals’ business is organized as a C-Corp, S-Corp, LLC, or Partnership. In this case, the business is organized as a C-Corp, which is the most favorable classification to avoid UBIT. And, in this case, since the Digitals have not yet accepted the buyer’s offer, the donation can be made well in advance of the acquisition becoming binding, thus avoiding pre-arranged sale concerns.

The Association gladly accepts the gift of shares from Dan and Diana, and within 6 months, the Association sells its shares alongside the Digitals in the acquisition and receives a seven-figure tax-free payout from the buyer. The Digitals and the Association use the major gift to endow a research fund, named after the Digital’s daughter, to focus on the causes and mitigation of congenital heart defects. The Digitals and the Association are thrilled with the gift and impact on research, not to mention the significant income tax savings for Dan and Diana, which is simply icing on the cake. Last but not least, the team of advisors are praised for their sound advice, and their relationships have deepened with their clients!

In closing, one might ask: Why not use a donor advised fund (DAF) as the vehicle of choice to receive this type of donation? While DAFs are certainly a popular option for gifts of business interests, there are many reasons why donating such assets directly to charity are in the best interests of the client and all parties involved. In my next Advisor Insights article, we will explore the pros and cons of donating business interests to a DAF versus directly to the operating charity. Stay tuned!

Disclaimer: This article is intended to be general information for educational purposes only. The hypothetical example provided herein is simplistic based on multiple variables and assumptions. This article is not intended to provide a comprehensive analysis of the legal and tax requirements associated with gifts of business interests. It is not intended to provide legal, tax, or financial advice. Clients should consult their qualified legal and tax advisors pertaining to their individual circumstances.

About the Author

Gunnar M. Crowell, JD
Senior Advisor, Charitable Estate Planning

Gunnar is based in Madison, Wisconsin and serves IA, IL, IN, KY, KS, MI, MN, MO, ND, NE, OH, SD, and WI.