Donating Closely Held Stock to Donor Advised Fund

Take-Away: The Tax Court recently held that a donor’s gift of closely held appreciated stock to a donor advised fund was not a taxable redemption of the stock, thus sustaining the donor’s charitable income tax deduction.

Reported Decision: Dickenson et ux. v Commissioner, No. 9526-19 Tax Court Memo 2020-128 (September 3, 2020)

Facts: The donor was the CFO and a shareholder of a privately held company, Geosyntec Consultants, Inc. (GCI.) GCI’s board of directors authorized its shareholders to donate GCI’s shares to Fidelity Investments Charitable Gift Fund (Fidelity’s donor advised fund.) In the GCI’s board of directors consent resolution it specifically acknowledged that Fidelity’s donor advised fund requires Fidelity “to immediately liquidate donated stock” and that Fidelity “seeks an imminent exit strategy and, therefore promptly tenders the donated stock to the issuer for cash.” This board resolution was adopted for three consecutive years by the GCI board. After each board resolution the donor gave appreciated CGI stock to Fidelity, while he remained as a full-time GCI employee. Each time the  GCI stock was gifted to Fidelity, (i) GCI confirmed by letter that its books and records reflected Fidelity as the new record owner of the transferred shares, and (ii) the donor signed a letter of understanding with Fidelity that acknowledged that the transferred GCI stock was “exclusively owned and controlled by Fidelity” and that Fidelity “maintains full discretion over all conditions of any subsequent sale” and that “the stock is not and will not be under any obligation to redeem, sell or otherwise transfer” the GCI stock. Fidelity then acknowledged and confirmed in writing the contents of those letters. Shortly after each transfer of GCI stock by the donor, Fidelity redeemed the CGI stock for cash. Each year of his stock donation to Fidelity, the donor claimed a charitable contribution deduction on his income tax return.

Dispute: The IRS issued a Notice of Deficiency to the donor. The IRS claimed the donor was liable for tax on the redemptions of the donated appreciated GCI stock. The donation of GCI stock to Fidelity, followed by the immediate redemption of the donated stock, the IRS claimed, should be treated in substance as a redemption of the GCI stock for cash by the donor, followed by the donation of the cash redemption proceeds by the donor to Fidelity. The legal issue before the Tax Court was whether the donations of GCI stock to Fidelity were taxable redemptions, resulting in capital gain recognition by the donor, followed by the donation of the cash proceeds to Fidelity, i.e. the donor failed to report as income the redemption proceeds.

Tax Court:  The Tax Court supported the donor’s claimed charitable income tax deductions.

• The Court started its analysis with the summary of the tax advantages of donating appreciated property rather than cash proceeds to a charity. ”Donating appreciated property to a charity allows the taxpayer to avoid paying tax that would otherwise arise if the taxpayer instead sold the property and donated the cash proceeds.”
• The form of this gift transaction, followed by a sale or redemption of the charity’s interest, will be respected by the Tax Court if the donor: (i) gives the property away absolutely and parts with its title;  (ii) before the property gives rise to income by way of a sale. Humacid Co. v Commissioner, 42 Tax Court, 894, 913 (1964). The first requirement is that there must be an absolute gift  of the stock by the donor so that the donor no longer holds any interest in the transferred property. The second requirement is that the donor must make the donation before the stock gives rise to income by way of  its sale.

The second requirement implements the IRS’ assignment of income doctrine: An individual who has earned income cannot escape taxation by assigning his or her right to receive the payment.

These two requirements thus ensure that if the stock is about to be acquired by the issuing corporation by virtue of a declared stock redemption, the shareholder cannot avoid tax on the transaction by donating the stock before the time he/she physically receives the redemption proceeds.

• The Court relied on the letters sent to Fidelity by both CGI and the donor’s letter of understanding provided to Fidelity, and Fidelity’s letter in response acknowledging that Fidelity had “exclusive legal control” over the donated stock, in order to reach the conclusion that the donor had made an absolute gift of the GCI stock before the stock’s redemption.
• The IRS then argued that the donor, GCI, and Fidelity could have arranged the stock redemptions in advance of the gifts of the GCI stock to Fidelity, i.e. a prearrangement. In response, the Court observed that a preexisting understanding among the parties that the donee-charity would redeem the donated stock “does not convert a postdonation redemption into a predonation redemption.”

“Furthermore, neither a pattern of stock donations followed by donee redemptions, a stock donation closely followed by a donee redemption, nor the selection of a donee on the basis of the donee’s internal policy of redeeming donated stock suggests that the donor failed to transfer all of his rights in the donated stock.”

• The assignment of income doctrine only applies if the redemption was practically certain to occur at the time of the gift, and it would have occurred whether the shareholder made the gift or not. Here, the donor did not avoid the receipt of redemption proceeds by donating his shares to Fidelity, as there was no board vote or resolution in support of the stock redemption. “The donor’s right to income [the redemption proceeds] had not yet crystallized at the time of his gift of stock to Fidelity.”

The taxpayer won this litigation in large part due to the ‘paper-trail’ that was created by both GCI and the donor with Fidelity, and the request that Fidelity acknowledge in writing that it had the ‘exclusive legal control’ over the donated GCI stock. Success was also based upon Fidelity’s published policy, important to GCI, that it would immediately liquidate any donated stock. If Fidelity had an obligation to redeem the stock that might have suggested that the donor had a fixed right to redemption income at the time of his gifts of GCI stock, but the Tax Court refused to address whether the stated Fidelity policy to immediately liquidate gifts of stock conferred on the donor any right to demand the stock redemption proceed.

Conclusion: This is a good case to remember with the nature of the board’s resolution limiting the authorization of the transfer of closely held stock to Fidelity due to its stated policy of immediate liquidation, and the exchange of letters between the corporation, the donor and Fidelity recognizing Fidelity as with the exclusive legal control over the transferred shares.

This is the second time that Fidelity’s immediate liquidation policy has recently come before the courts. Here, the policy was to the taxpayer’s benefit, although it did elicit a novel assignment of income argument from the IRS. In the other reported decision, still grinding its way through the trial courts, the donor claimed that he was precluded from claiming a larger charitable income tax deduction because Fidelity actually followed its policy and promptly liquidated a very large bloc of publically traded stock literally within hours on the same day as the gift, resulting in large valuation discounts for the price obtained by Fidelity.