Taxes in Your Practice: Charitable deduction sustained for stock contribution to donor advised fund

Background
Petitioner Jon Dickinson was the chief financial officer and a shareholder of a privately held company, Geosyntec Consultants, Inc. (GCI). During each of the tax years in question, the GCI board authorized shareholders to donate GCI shares to a § 501(c)(3) tax exempt Fidelity Investments Charitable Gift Fund (Fidelity). Pursuant to Fidelity’s donor advised fund program, GCI understood that Fidelity would immediately liquidate the donated stock by tendering it to GCI for cash. Dickinson donated appreciated GCI shares to Fidelity after the GCI board approvals in each year, and he remained employed with GCI following the donations. GCI, Fidelity, and petitioner confirmed by agreement and letter of understanding (LOU) that the transferred stock was exclusively owned and controlled by Fidelity; that Fidelity was under no obligation to redeem, sell, or otherwise transfer the stock; and that Fidelity had exclusive legal control over the contributed assets. Fidelity did tender the shares to GCI for cash shortly after each donation.

Petitioners claimed charitable deductions for the contributions of GCI shares to Fidelity for each of the years in question. The IRS determined that petitioners were liable for tax on redemption of the donated GCI shares and proposed a penalty for each tax year. Petitioners sought redetermination of the deficiencies and penalties in Tax Court and filed a motion for summary judgment on the issues addressed in the case.

Analysis
Code § 170 allows a taxpayer to deduct the fair market value of appreciated property donated to a qualified charitable organization. The court noted that this allows a taxpayer to donate appreciated property to charity to avoid paying tax that would arise if the taxpayer simply sold the property and donated the cash proceeds.

The IRS determined that the donations of GCI shares followed by Fidelity’s exchange of the shares for cash should be treated in substance as a redemption of the shares by petitioner, followed by a donation of the cash redemption proceeds to Fidelity by petitioner. Reciting prior cases, the court found that the form of these transactions (rather than the substance pursued by the IRS) will be respected if the donor (i) gives the property away absolutely and (ii) parts with title to the property before a sale of the property gives rise to income.

With respect to the first requirement, the court reviewed the agreements, letters, and LOUs among GCI, Fidelity, and petitioner and found that they supported petitioner’s claim that all rights in the GCI shares were transferred to Fidelity. The IRS argued that Fidelity’s pattern of regularly redeeming the GCI shares shortly after each donation pursuant to the GCI board’s understanding of Fidelity’s internal procedures basically converted the after-donation redemptions into pre-donation redemptions. However, the court found that “neither a pattern of stock donations followed by donee redemptions, a stock donation closely followed by a donee redemption, nor 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.” Based on this finding and the petitioners’ contemporaneous documentation of an absolute gift, the court concluded that petitioner’s donations satisfied the first requirement.

With respect to the second requirement, the court noted that donating stock prior to the stock giving rise to income by sale may be subject to the assignment of income doctrine, which prevents a taxpayer who has earned income from assigning a right to receive payment to escape taxation. The court found that the assignment of income doctrine would apply only if the redemption was “practically certain to occur at the time of the gift, and would have occurred whether the shareholder made the gift or not.” On this point, the court determined that the redemption in this case was not “fait accompli” when the gift was made. Even if the parties may have prearranged for Fidelity to redeem the GCI shares, the court respected the form of the transaction, finding that petitioner “did not avoid receipt of redemption proceeds by donating the GCI shares” because the redemption and petitioner’s corresponding right to income had not yet crystallized at the time of the gift.”

Based on these findings, the court held that the petitioner made an absolute gift of the GCI shares each year in question before the shares gave rise to income by way of a sale, and granted petitioners’ motion for summary judgment.

Conclusion
The Dickinson case supports a contribution strategy involving the donation of appreciated stock to charity prior to sale or redemption of the stock. As with Fidelity in the Dickinson case, charitable organizations may have internal policies to liquidate stock on receipt, giving closely held companies some assurance that they will not have an ongoing charitable shareholder. However, Dickinson also highlights the possibility of an IRS challenge to these transactions, and the importance of the underlying documentation to establish an absolute gift and timing to ensure the gift is completed before any income-generating events.

Endnote
1 Scott E. Vincent is the founding member of Vincent Law, LLC in Kansas City.