Estate planners often use the gift of S corporation stock to improve retirement income as part of a much broader business succession plan. Frequently included in such planning is the gift of S corporation stock to charities. But some gift strategies work much better than others.

Outright Gift of Stock to Charity: While a donor can directly gift S corporation stock to a charity, complications arise from the fact that the charity normally does not wish to hold onto the S corporation stock for too long a period, so other individuals need to be ready to purchase the S stock from the charity or the corporation needs to possess sufficient liquidity to redeem the gifted S stock from the charity.  Moreover, if there is a restrictive stock agreement in place among the S corporation shareholders, other shareholders may have to consent to the gift of S corporate stock by one shareholder to a charity. If the charity holds onto the stock for any appreciable period of time, it possesses rights to review the financial records of the corporation, the right to vote, and perhaps the right to compel the liquidation the corporation depending upon the size of the charity’s voting interest, which may be disconcerting to the remaining S shareholders. In reality, most S corporations are closely held, and the charity will be viewed as an outsider by the remaining shareholders with regard to the day-to-day operations of the corporation, making the charity often an unwelcome shareholder. In sum, a gift of S corporation stock to a charity carries with it some expectation [but no pre-arrangement under the tax laws] that the S corporate stock will be redeemed from the charity, or purchased by other individuals who will be acceptable to the existing shareholders of the S corporation.

Charity Remainder Trust (CRT): A CRT, either a unitrust or an annuity charitable remainder trust, cannot legally be a shareholder of an S corporation.

Charitable Gift Annuity (CGA): A CGA can be funded with S corporation stock, but there exists a hidden complication that reduces the valuation base upon which the donor’s annuity payout is determined. The charity that receives the S corporation stock will have unrelated business income (UBI) on its share of the S corporation income and on its gain from the disposition of the S corporation stock. Often the recipient charity will require an annuity payout rate to the donor that is less than the recommended rate suggested by the American Council on Gift Annuities due to these tax liabilities; the charity will have to pay income taxes on the unrelated business income taxes on its distributive share of S distributions and any realized capital gains. [Note, too, that the donor would have a lower federal income tax charitable deduction since the value of the donor’s gift must be reduced by ordinary income items under IRC 170(e)(1), but this lower value might be offset, somewhat, by the increase in the value of the remainder interest given to the charity, since the annuity payout rate to the donor will be smaller than what would normally be the case under the American Council’s recommended rate of annuity payout.]

Possible Solutions:

While a CRT cannot be a shareholder in an S corporation, the S corporation can fund a CRT with an appreciated asset that it owns. Private Letter Ruling 9430043 (May 6, 1994.) In that PLR the CRT paid income to the donating corporation for a fixed term. The charitable deduction that was available to the corporation then flowed through the S corporation to the S corporation shareholders. For the CRT to be qualified under the tax code, its duration must be limited to a fixed term- no more than 20 years. This strategy assures the shareholders of the S corporation a charitable deduction, and it reduces the value of their interest in the S corporation since the corporation just donated  presumably a valuable asset from its balance sheet to the CRT.

A gift of S corporation property is more beneficial to fund a charitable gift annuity too,  than a gift of S corporation stock. There is no need to discount the value of the gifted asset [an asset in contrast to a gift of an illiquid, possibly minority interest in, unmarketable S corporation stock]. Thus, the full fair market value of the gifted asset would be deductible to the S corporation. In addition, because the charity would not have its interest diminished by income taxes on the unrelated business income from its distributive share of the S corporation, or any future sales proceeds, the charity will not seek a payout annuity rate less than the American Council’s recommended rate. Finally,  the recent Protecting Americans from Tax Hike Act of 2015 (aka the PATH Act) made permanent the extension of basis adjustment to stock of S corporations that make charitable contributions of their property.

In sum, it is much better for an S corporation to directly gift assets to charities [CRTs or CGAs] than for the shareholder of an S corporation to gift their S stock to a charity.