Tax strategy that charitably inclined business owners should be aware of when selling a business

When selling a business, owners who are charitably inclined can get a much bigger charitable bang for their buck if they plan ahead and take action before the sale, rather than making a donation after the sale with the sale proceeds. The key is to make a donation of company stock to a donor advised fund (DAF) shortly before the sale closes. This allows the owner to not only deduct the value of the donation, but also to avoid capital gains tax on the sale of the donated stock. The donor can then direct the funds to charities of their choice over the following years. This strategy is far more tax-efficient than making a donation after the sale or making a donation to the owner’s private foundation.

Privately held business valuations for non-controlling interests are subject to discounts for lack of control and lack of marketability by the IRS. Generally, gifted interests are a non-controlling interest in the business. The lack of control the charity will receive in the business when gifted its interest and the lack of ability to quickly liquidate the interest, creates an inherent lack of control and lack of marketability that make the interest worth less. However, when a business owner is proactive and structures a charitable gift ahead of a planned sale of the business, the following can be accomplished:

 

1. In order to maximize the tax strategy and giving power, the business owner has an incentive for a business valuation tobe as high as possible in order to maximize the offset to the capital gain. For privately held businesses, discounts for lack of control and lack of marketability could have substantial impacts to the overall value of the company, so by creating a path to liquidity for the gifted interest by way of a planned sale of the company, this makes the value of the non-controlling interest in the company worth more.
2. A business valuation expert can support substantially lower discounts for lack of control and lack of marketability in the presence of a known liquidity event in the near term. It is important to recognize that this approach is only effective if the gift happens prior to execution of the sale.
3. Following the gifted interest to the charitable organization, the sale of the business is then executed within a short-term. The sale provides a liquidity event for the charity and the business owner’s capital gains from the sale of the business are offset by the gift, providing favorable outcomes for both parties. Furthermore, in many cases, business owners have the giving power to gift more than they would have through the traditional gifting approach because of the tax savings this approach allows for.