As I discussed in a prior post, a donation of closely-held stock to a charitable organization can be highly tax efficient because (1) the donor receives a deduction for the fair market value of the donated asset, (2) the donor avoids paying tax on the asset's built-in gain, and (3) the charity, being tax-exempt, also avoids paying tax on any gain from the sale of the asset. However, the IRS has historically and in recent years especially challenged the avoidance of tax on the built-in gain under what is known as the "assignment of income" doctrine.
Often, a donation of stock or interest in an LLC occurs shortly before the sale of the business. In these cases, the IRS argues that the donor's right to proceeds from the sale of the donated interests became "fixed" or “practically certain to occur" before the gift was actually made, meaning that the donor would be required to pay tax on the gain built into the interest transferred to the charity.
Whether the donor's right to the proceeds associated with the gifted interests is "fixed" is a facts-and-circumstances test. In Estate of Hoensheid v. Commissioner, T.C. Memo. 2023-34 (2023), the court looked at a donation that occurred shortly before a sale and considered factors including the status of the revisions of transaction documents at the time of the gift, the target company taking actions that presuppose the sale will close, any legal obligation to sell by the donee, and the status of the corporate formalities required to finalize the transaction.
The court in Hoensheid ruled against the taxpayer in a circumstance that was similar to many donation and sale transactions. There are indicators that the IRS is automatically pulling for audit any in-kind gift make within two weeks of the liquidity event, although legally there is still no bright-line rule on timing in an assignment-of-income case. Anyone contemplating a donation of a closely-held business interest before selling their business should obtain experienced legal counsel before undertaking such a transaction.
Often, a donation of stock or interest in an LLC occurs shortly before the sale of the business. In these cases, the IRS argues that the donor's right to proceeds from the sale of the donated interests became "fixed" or “practically certain to occur" before the gift was actually made, meaning that the donor would be required to pay tax on the gain built into the interest transferred to the charity.
Whether the donor's right to the proceeds associated with the gifted interests is "fixed" is a facts-and-circumstances test. In Estate of Hoensheid v. Commissioner, T.C. Memo. 2023-34 (2023), the court looked at a donation that occurred shortly before a sale and considered factors including the status of the revisions of transaction documents at the time of the gift, the target company taking actions that presuppose the sale will close, any legal obligation to sell by the donee, and the status of the corporate formalities required to finalize the transaction.
The court in Hoensheid ruled against the taxpayer in a circumstance that was similar to many donation and sale transactions. There are indicators that the IRS is automatically pulling for audit any in-kind gift make within two weeks of the liquidity event, although legally there is still no bright-line rule on timing in an assignment-of-income case. Anyone contemplating a donation of a closely-held business interest before selling their business should obtain experienced legal counsel before undertaking such a transaction.
