Rare but powerful “charitable exits”: Plan ahead for charitable impact

As the baby boom generation ages, a rising number of business owners are selling their businesses. A survey by the Exit Planning Institute revealed that over 70% of business owners aged 50 or older planned to exit their businesses within the next ten years.

If you are one of these business owners and philanthropy is in your plans, there are significant benefits from giving closely-held business interests to charity. But to do so, it is crucial to plan well ahead of any sale.

You may know that the value of your business has grown substantially over the years, accumulating significant unrealized capital gains. If you sold now without additional planning, a large portion of the proceeds would go toward capital gains tax, potentially eroding the value he had worked so hard to build. 

Normally, business owners might rush into the exit process with their financial advisors by putting feelers out to potential buyers, determining an asking price, jumping to establish a letter of intent with a leading suitor, and in the process, missing strategies that could improve their post-sale outcome.

However, to maximize your charitable impact, it’s important to involve the community foundation early in the process.  It’s worth considering giving a portion of the company’s shares to a donor-advised fund at the community foundation before any formal sale activities begin. By making this charitable gift well in advance of the eventual sale, the shares owned by the donor-advised fund will not trigger capital gains. Instead, the donor-advised fund will receive the proceeds free of capital gains tax and ready to deploy toward your philanthropic goals. What’s more, this technique delivers an estate tax advantage by removing the gifted portion of the business from your taxable estate.

The most important tip to remember is to reach out to the community foundation team during the very early stages of planning your business exit. Transactions like this take time and require navigating a few pitfalls. For example:

• Obtaining a qualified appraisal is crucial to comply with IRS rules for charitable deductions for gifts of non-cash assets. Failure to strictly comply with IRS rules could wipe out the tax deduction.
• For this type of transaction to avoid capital gains tax, it is important that no formal discussions about the sale, no shareholder vote approving a transaction, and no signed letter of intent are in place before the gift of shares. Otherwise, the IRS may disallow the charitable deduction.
• These transactions are typically much more effective when the stock is given to a public charity, such as the community foundation, rather than a private foundation. Unfortunately, some tax advisors are not aware of the significant differences in the tax benefits of giving closely-held business shares depending on the IRS status of the receiving entity. And of course, the community foundation reviews each potential gift carefully to ensure compliance and feasibility.

Your success as a business owner will allow you to enjoy what comes next. With careful planning that can include a boost in your charitable giving.  Talk to your financial advisor early in your thinking and then reach out to us at the Community Foundation.