Giving Stock: A Tax Break For Business Owners

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If you have ever written a check to the United Way, you know that charitable contributions reduce your taxes and thus "cost" less than they appear to. If you are in the 50% bracket, for example, a $500 contribution sets you back only $250.

The truly powerful opportunities for tax savings, however, lie in contributions of securities that have gone up in value. In most cases, you can deduct the current market value of contributed stock (provided you have held it for at least one year), at the same time avoiding the tax on your capital gain. Say you bought stocks several years ago for $5,000 that are now worth $10,000. If you sold the shares and donated the cash to charity, your deduction would be offset by a $1,000 capital gains tax (20% of the appreciation for those in the top bracket). Give the stocks themselves, and you get the full value of the $10,000 deduction.

An owner of a successful small business -- whose stock in the company may have cost next to nothing -- is particularly well situated to take advantage of this tactic. Since the Internal Revenue Service has challenged some similar deductions, however, a little care is in order.

For starters, it is likely that neither you nor your favorite charity wants the charity to become-a permanent stockholder in your company: The charity wants the cash, and you want to retain full ownership. The best outcome would be to have your corporation buy back the donated stock and retire it. That would give al concerned what they want, and it would let you take the stock's full value as a deduction without capital-gains liability.

The major catch in this scheme is that you can't legally bind the charity to sell the stock back to the corporation, or indeed to do anything else with it. In one recent case, for example, a taxpayer donated stock in his company (cost: $98; value: $686,875) with the understanding that the charity would sell it and use the cash to buy a yacht from the donor, which it did. The IRS was able to prove that a legally enforceable agreement existed and that the taxpayer would not have donated the stock without the charity's promise to buy his yacht. So the deduction was disallowed.

The court in this case adopted a rule even tougher than the IRS's, saying that any "understanding" between the donor and the charity was enough to throw out the deductions. In other words, simply avoiding a legal contract won't ensure that the transaction will be accepted.

In view of this unexpectedly hard line, the best bet is probably to avoid discussing with the charity any of its plans to cash in the stock. It is probably all right to respond to the charity's questions about what it might do with the stock, but you should not imply that the donation hinges on an assurance that the charity will sell the stock to your company.

If you can live with this element of legal doubt, however -- and if your own lawyer gives you the go-ahead after reviewing the particulars of your case -- you may find that charitable contributions can be a significant source of tax benefits as well as of personal satisfaction. Before you write out a check, make sure you are not missing a chance to do more good at lesscost.