Case:

Barbara Banker started with nothing. She lived in a midsized town and worked in the local hardware store. The store owner noticed her industrious efforts and strong work ethic. When he decided to retire, he suggested Barbara take over the hardware store and pay him from store profits over a term of 10 years. Barbara did exactly that. When the town drugstore owner wanted to retire, Barbara bought the store under a similar plan. Later, Barbara started buying apartment buildings in town. Because she needed financing for these purchases, Barbara became good friends with the town bankers.

Two bankers eventually approached Barbara about starting a new local bank. She agreed to be one of the initial directors and they all invested in the local bank, which they named LoBank. Over the years, the bank's services and value greatly increased. Barbara is a respected executive and owns a large block of LoBank stock.

As a strong supporter of her local community, Barbara gives regularly to her favorite local charity. She would like to make a large gift of bank stock to the local charity to be used to build a new youth center. But as a director she knows that LoBank's directors have approved signing a letter of agreement for the sale of all stock to MegaBank, a bank located in a nearby large city. Barbara decides to meet with her counsel to discuss the gift.

Question:

Barbara explained, “My favorite charity has a naming opportunity for the new youth center and has asked me if I would consider making the lead gift. I am interested in supporting youth, and this center would be a fine addition for our town. The LoBank stock has gone way up in value, but I have heard that there may be problems with this gift now that the board voted to accept the offer from Megabank. Can I still make this gift? Are there any problems?”

Solution:

Barbara’s CPA explained that if she makes a gift of LoBank stock, there will not be any bypass of the capital gain. Typically, the third step in the bank sale process is a vote by the board of directors to accept the buyer's offer and submit the proposed sale to the shareholders. Normally, the vote by the board of directors does not create a binding obligation for sale.

Under applicable state law, the sale of a corporation will not be completed without a vote by more than 50% of the shareholders. However, if the directors own more than 50% of the shares, the IRS may take the position that the vote by the board of directors is equivalent to a vote by more than 50% of the shareholders and that there is a binding agreement.

Because the directors of LoBank collectively own 55% of the total shares and voted for the sale, the probability that the sale will not go through is "remote and hypothetical” and therefore irrelevant. Therefore, the vote by the shareholders is a mere formality. It is probable that the IRS and the Tax Court would conclude that the obligation is now effectively binding, and the sale is subject to the binding agreement standard of Rev. Rul. 78-197. Income is taxed "to those who earn or otherwise create the right to receive it." Thus, the doctrine of assignment of income applies because Barbara as a shareholder has a right to the income from the sale, regardless of if it has been received yet.

In Estate of Scott M. Hoensheid et al. v. Commissioner; No. 18606-19; T.C. Memo. 2023-34 (Mar 15, 2023), the Tax Court determined the taxpayer transferred stock to a donor advised fund (DAF) after the business sale was virtually certain and the gain had ripened. There was no bypass of capital gain on the gift and the taxpayer did not receive a charitable deduction because the appraisal and appraiser failed to meet the applicable requirements.

Similarly, for sales of small, closely-held corporations such as local banks, or for sales of mid-sized or even large public corporations, the natural proclivity is towards procrastination. Shareholders frequently do not want to make decisions until there is a clear sale and specified price. Because negotiations can be extended over months or even years, there is an understandable inclination towards delaying for the last minute before making charitable plans.

In Hoensheid, Scott Hoensheid indicated to attorney Andrea Kanski he was interested in creating a DAF with Fidelity Charitable. Ms. Kanski stated to Scott, "The deadline to assign the stock to a donor advised fund is prior to execution of the definitive purchase agreement." Scott responded, "I would rather wait as long as possible to pull the trigger."

Barbara will not be able to bypass the gain on the LoBank stock if she makes a gift of the stock at this time.