Helping Clients Convert a Business Interest into Charitable Capital
If your clients are among the 18.7 million Americans who own their own business, you probably understand what a powerful asset their business is. Chances are you have already discussed how a business sale fits into your clients’ retirement planning, but have you considered how it fits into their charitable planning?
Selling a business can be a stressful undertaking, and it can seem easier to support a charity by donating cash out of the proceeds once the sale is over. What’s more, many charities can’t accept contributions of complex assets like private business interests—which can lead clients to assume that a cash donation is a better and simpler option.
However, by incorporating a charitable plan into your clients’ sales strategy and giving prior to the sale, you can help your clients save on taxes and have more to give.
Business owners can use a donor-advised fund (DAF) to make direct, tax-efficient contributions of private business interests before any agreements are in place to sell the company. Donors receive an immediate tax benefit and, after the DAF sponsor liquidates the asset, they can grant the proceeds to qualified charities of their choice over time.
To illustrate this strategy, imagine Cristina is selling her business, which has been appraised at $2.5 million. She wants to contribute the proceeds to charity. Here’s how her timing affects the outcome:
OPTION ONE: Cristina sells the business first
Cristina sells the business for $2.5 million.
She realizes a capital gains tax of 23.8%*—or $595,000.
By the time she makes her donation, she has $1,905,000 left to give.
OPTION TWO: Cristina donates to a DAF first
Cristina contributes $2.5 million worth of shares to a DAF.
She avoids the capital gains tax by giving it as a charitable contribution.
The full $2.5 million funds her DAF, where it is invested and can potentially grow before being granted to Cristina’s favorite charities.
The second strategy allows Cristina to avoid capital gains tax and donate the full value of the shares. As an added personal benefit, the larger contribution also further reduces her taxable income, as she could be eligible for a bigger deduction on her federal tax return: up to $925,000, assuming a 37% marginal income tax rate, compared with $704,850 if the asset was sold first and then contributed after accounting for capital gains taxes.
And for philanthropically-minded business owners like Cristina, this strategy means that more money is preserved for the charities closest to their hearts.
Using a DAF is a great way to realize the full charitable potential of a private business sale. To learn more about how donor-advised funds can be used as a charitable planning tool in a business transition, click here.
*This hypothetical example assumes a 20% capital gains rate with a 3.8% Medicaid surtax and a zero cost basis.
Fernando Gonzalez is the Regional Director of Development, Mid-Atlantic at National Philanthropic Trust. He has eleven years of wealth management experience, as well as five years’ experience in real estate and mortgage consultancy, and a rich history of finance, governance and community engagement.
NPT does not provide legal or tax advice. This blog post is for informational purposes only and is not intended to be, and shall not be relied upon as, legal or tax advice. The applicability of information contained here may vary depending on individual circumstances.
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Catch up on the rest of the DAF Insights for Advisors series:
Four Reasons to Talk to Clients about Donor-Advised Funds by Andrew Hastings, Chief Development Officer
How to Talk with Clients about Donor-Advised Funds by Ellen Galluccio, Director of Development, Northeast Region
Three Key Moments to Talk to Clients about DAFs by Eric Joranson, Senior Director, Advanced Strategies
Donating Pre-IPO Shares to a Donor-Advised Fund by Jeff Gerold, CFP, Senior Director of Development, Southwest
IRA Charitable Rollovers: Helping Clients Put a Distribution to Good Use with a Designated Fund by Ethan Burke, Director of Development, Southeast
Do Your Clients Need to Update their Estate Plans? Here’s How a Donor-Advised Fund Can Help by Eric Joranson, Senior Director, Advanced Strategies