By Joy S. MacIntyre, Morrison & Foerster LLP
In an earlier post we described
some of the tax benefits - and challenges - associated with donating corporate
securities to a family foundation or other private foundation. On the right facts, the donor in such a case
can claim a deduction equal to the full fair market value of the securities
despite the fact that the donor will never be taxed on any gain built into the
securities. We previously discussed some
of the foundation-side implications (specifically, the minimum distribution
requirement and the excess business holdings limitation) that must be
considered in connection with such a contribution. This installment will take up the key
donor-side income tax constraint that must be considered before making such a
contribution, specifically, the requirement that the securities must be
"qualified appreciated stock" of a corporate issuer at the time of the
contribution or the deduction may be severely curtailed.
Appreciated Stock" Generally
The Internal Revenue Code generally
limits the deduction for a contribution of capital gain property to a private non-operating
foundation, so that the best a donor in such a case can hope for is a deduction
equal to the adjusted tax basis in the contributed property.1 A taxpayer-favorable exception exists for a
contribution of "qualified appreciated stock," offering the donor of such stock
the possibility of a full fair market value deduction - without accompanying
gain recognition - provided all of the following requirements are met:2
contribution must be of corporate stock; securities issued by a
partnership and bonds, notes, warrants or other non-stock interests issued
by a corporation cannot qualify even if they are clearly and actively
- As of the
date of the contribution, market quotations for the stock must be readily
available on an established securities market (the "Publicly Traded
- The stock
must be "capital gain" property; that is, a sale of the stock for its fair
market value at the time of the contribution would have resulted in long-term
- The donor
(together with certain family members) must not have contributed to
private non-operating foundations stock in the same corporation
representing, in the aggregate, more than 10% of the value of the
corporation (the "10% Limitation").
For the typical portfolio investor
in publicly-traded stocks, application of the above requirements tends to be fairly
straightforward, and the provision easily satisfied. Much greater care is required, however - and
in some cases the exception will be unavailable in whole or in part - where the
donor is a founder of the corporation in question and has retained a significant
equity stake or other position of influence with the company. Such a fact pattern can raise nuanced
questions under the Publicly Traded Requirement and the 10% Limitation, some of
which are illustrated below in the context of a hypothetical fact pattern similar
to those sometimes encountered in practice.
Publicly Traded Requirement
Suppose an individual donor ("D")
founded a corporation ("Co") many years ago. In connection with its initial public
offering of stock ten years ago, Co recapitalized its shares so that the class
of stock owned by D and D's family members had a disproportionately high number
of votes per share compared to the class of stock owned by the public
investors. This is a fairly common feature
in public offerings of family-owned corporations, as it allows the family to
retain voting control (say, 85% of the voting power) while increasing the
amount of stock that can be sold to the public (say, 50% of the value).
Co's low vote stock is traded on
the New York Stock Exchange. Although the
class of high-vote stock owned by D is not itself listed on any public
exchange, D has complete discretion to convert his shares into the low-vote
shares at any time, on a one-for-one basis.
D would like to contribute some of
his Co shares to a private non-operating foundation ("Foundation"). Is D's contribution of the high-vote class to
Foundation eligible for the exception?
The IRS position, reflected in a 1999 private letter ruling,3 is
that the exception is not available because the contributed shares are not of
the class that is publicly traded - D's unrestricted, unilateral right to
convert into the public class is not enough.
Therefore, D must first convert his shares into the publicly traded,
low-vote class before contributing them to Foundation.
Now suppose that the high-vote
shares owned by D and his family have not been registered under the securities
law. Alternatively, or perhaps in
addition, suppose D remains an officer and director of Co, or owns a
significant stake in Co. In any of the
foregoing cases, D's ability to sell his Co shares would be limited by Rule 144
of the Securities Act of 1933. Rule 144
generally restricts D's sales within any three month period to the greater of
(a) 1% of the outstanding shares of Co and (b) the average weekly trading
volume of Co within the four week period preceding the sale. Assume no contractual or other transfer
restrictions apply to the shares.
While Rule 144 volume restrictions
do not directly apply to a gift transfer such as D's proposed contribution of
shares to Foundation, the IRS is of the view that the restrictions nonetheless
are relevant in determining whether D's stock satisfies the Publicly Traded
Requirement.4 Specifically, the IRS has interpreted the
Publicly Traded Requirement to mean that the shares in question must actually
be freely transferable by the donor at the time of the transfer and by the
donee following the transfer.5 It therefore is critical to evaluate whether
any contractual or legal restrictions limit the transferability of the shares
before or after the contribution. The
answer is likely to require interpretation of the securities laws as well as
the corporate charter, corporations code and perhaps investment agreements, and
in practice a corporate colleague typically is consulted on these points. Some generalizations follow, however.
On the donor side of the equation,
as discussed above, for one or more reasons we would expect D's ability to
transfer the Co shares to be limited in accordance with Rule 144. Is D's contribution therefore ineligible for
the exception? Not necessarily. D should be able to donate, and treat as
"qualified appreciated stock," a number of shares up to the number that D could
have sold on the contribution date without violating Rule 144's volume
restrictions;6 that number of shares is in
fact freely transferable in D's hands. However,
while it does not appear the IRS has expressly addressed this point, it may be
prudent for D to avoid making additional transfers of Co shares within the
three month period following the contribution to Foundation if the combined
effect of the later transfers and the contribution to Foundation would be to
transfer an aggregate number of Co shares in excess of D's Rule 144 volume
limit (treating the charitable contribution as if it were a Rule 144 restricted
transfer for this purpose).
As noted above, in order to ensure
the exception is available the shares also must be freely transferable in the
hands of the donee foundation. While, again,
the point is best confirmed by a corporate attorney on a specific set of facts,
our experience has been that in a typical case a private foundation is unlikely
to be subject to transfer restrictions on contributed stock. In general, securities law restrictions might
apply if the donee foundation were considered the same "person" as the donor
under the securities law, a determination that takes into account the
charitable bona fides of the foundation, the "affiliate" status of the
foundation and the corporate issuer, and whether the foundation will own "substantially
less" than 10% of the issuer's outstanding shares.
"Affiliate" status for this purpose
is generally a facts and circumstances determination, with some emphasis on
whether, directly or indirectly, one entity controls the other or the two
entities are under common control. For
example, ownership by a foundation of ten percent or more of a corporate
issuer's outstanding securities would be among the facts tending to indicate
affiliate status. Based upon the
foregoing standards, in most situations encountered in practice the donee
foundation is able to freely transfer the contributed shares as required for
the "qualified appreciated stock" exception to be available.
Similar care must be exercised in
applying the 10% Limitation, both to D's initial contribution of Co shares to
Foundation and to any additional contributions of Co shares D might
contemplate. The limitation is seemingly
straightforward: The qualified
appreciated stock exception is unavailable for a cumulative contribution of shares
having a value in excess of ten percent of the value of all of Co's outstanding
stock. In applying the limitation, D is
deemed to have made any contributions of Co shares that in reality were made by
members of D's family, which includes for this purpose only D's siblings,
spouse, ancestors and lineal descendants.
Interesting questions arise if D
has (or is deemed to have) contributed Co shares on one date ("Date 1")
and contemplates contributing additional shares on a later date ("Date 2"). Assume the shares contributed on Date 1 were
well within the 10% Limitation as tested on that date. In such a case:
Should the shares contributed on Date 1 continue
to be valued at their Date 1 value for purposes of applying the 10% Limitation
on Date 2? The IRS has indicated in a
private letter ruling that the earlier-contributed shares should continue to be
valued at their Date 1 value in determining the numerator for the 10%
Limitation, even though the denominator is based on the total value of all of
the outstanding Co stock on Date 2.7 This approach will be favorable to D,
assuming Co stock has appreciated between Date 1 and Date 2.
In applying the 10% Limitation on Date 2, must
the Date 1 contribution be taken into account even if as of Date 2 Foundation
no longer owns any of the shares that were contributed on Date 1? Yes; this result seems clearly supported by the
statute's focus on the quantum of shares contributed by D rather than on the
quantum of shares owned by Foundation, and is consistent with the private
letter ruling position taken by the IRS.8
Does the 10% Limitation apply on a
foundation-by-foundation basis? Or does
it apply on an aggregate basis to all of D's contributions of Co stock to
private non-operating foundations? Although
the statute itself arguably is not perfectly clear on this point, the
legislative history underscores that the 10% Limitation applies on an aggregate
basis taking into account all of D's actual or deemed (by family attribution) contributions
of Co stock to all private non-operating foundations, not simply those
contributions made to Foundation.9
A contribution of qualified appreciated
stock to a private non-operating foundation can offer potent income tax
benefits to the donor. Changes in the
tax rules that went into effect at the beginning of this year resulted in some refinements
- some good, some bad - to the basic framework for assessing those benefits. The increase in tax rates on long-term
capital gains (up from 15% to a maximum of 23.8% for taxpayers in the highest
bracket, taking into account the new 3.8% Medicare surtax) increases the value
of the "gain nonrecognition" benefit to the donor. At the same time, the reinstatement of the
itemized deduction phase-out limits the value of the charitable deduction benefit
to many donors. All told, the recent law
changes place a high premium on careful modeling of the expected tax impact to
the donor of donating qualified appreciated stock, but do not undermine the
basic advantages of such a contribution compared to a gift of the after-tax
cash that might be generated by a sale of the stock.
The above discussion focuses solely
on the donor's income tax considerations relating to a contribution of
qualified appreciated stock. A number of
corporate law and other practical considerations also should be taken into
account in determining the size and attractiveness of such a gift. Among other things, consideration should be
given to securities law restrictions that might apply to a donor's transfer of
other stock of the same issuer following the contribution, and to the market
impact of any threshold conversion of shares that would increase the number of outstanding
shares in the publicly traded class.
Morrison & Foerster's Trusts and
Estates group provides sophisticated planning and administration services to a
broad variety of clients. If you would
like additional information or assistance, please contact Patrick McCabe at
(415) 268-6926 or PMcCabe@mofo.com.
© Copyright 2013 Morrison & Foerster
LLP. This article is published with
permission of Morrison & Foerster LLP.
Further duplication without the permission of Morrison & Foerster
LLP is prohibited. All rights
reserved. The views expressed in this
article are those of the authors only, are intended to be general in nature,
and are not attributable to Morrison & Foerster LLP or any of its
clients. The information provided herein
may not be applicable in all situations and should not be acted upon without
specific legal advice based on particular situations.
1. I.R.C. §170(e)(1)(B).
2. I.R.C. §170(e)(5).
3. PLR 199915053.
4. See, e.g., PLR 9247018
(stock was not qualified appreciated stock because taxpayer was prohibited from
selling the stock under Rule 144); PLR 9320016 (reconsidering and confirming
the result in PLR 9247018 on the view that it is required by the legislative
5. See, e.g., PLR 200702031.
6. See, e.g., PLR 9435007.
7. PLR 200112022.
9. See H. Rep. No. 432, Part
2, 98th Cong., 2d Sess. 1464-65 (1984) (limitation applies to
donor's contributions "to all private nonoperating foundations of stock in a
particular corporation"); Staff of the Joint Committee on Taxation, General
Explanation of Revenue Provisions of the Deficit Reduction Act of 1984, 98th
Cong. 669 (1984) (requiring aggregation with all other contributions of stock
in the same issuer "to all other related or unrelated private nonoperating
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