Good business owners are known for their ability to capitalize on opportunity. This is especially true when they decide to sell their business. More and more, business owners are using what is likely their largest influx of income as the charitable opportunity of a lifetime.
“Business owners are faced with what to do after the sale and also how to cope with one of the biggest expenses in their lifetime, which is the income tax on gains from the sale,” says Thomas A. Kotick, CPA, CFP®, director at SS&G. “That gets a lot of people talking about what to do to minimize the impact of those taxes. It’s a good time for business owners to reflect.”
Smart Business spoke with Kotick about how charitable contributions can be used to reduce income tax burden and leave a legacy of goodwill in a business owner’s community.
Why do so many business owners include charity as part of their exit strategy?
The community in which a business operates is a big reason for its success, so charitable giving is most often a token of gratitude for the community’s support. As a financial strategy, making a charitable contribution as part of a sale event can significantly reduce the income tax burden.
Depending on how much the business is worth, selling a business could boost the owner’s net worth to a point at which he or she is subject to estate tax. Anyone with more than $5.34 million in assets is subject to a 40 percent estate tax. By giving away part of the income from a sale, the owner has less estate tax exposure.
What options do business owners have when donating their closely held shares?
One option is for an owner to donate a portion to charity. If a charity sells those shares, it isn’t required to pay income tax on the sale. When the donation is in this form, a decision regarding the amount needs to be made prior to the sale.
Business owners can also take the cash from the sale, pay tax on the income and give a portion to charity, which is tax deductible. A direct gift to a public charity gives a business owner a favorable tax benefit, but the decision on where the gifts go must be made that same calendar tax year.
Another option is to create a private foundation. The foundation can bear the family name and allow the delay of charitable decisions, but it can be a lot of work. This legal entity requires family management, the filing of tax returns and distribution of 5 percent of assets annually. In addition to a smaller tax break on contributions, private foundations also pay an excise tax. It is one option for carrying on a person’s legacy, but it requires a willingness to manage and file tax returns.
Are there any less complicated options?
You can create a donor-advised fund by giving an irrevocable gift to an administrating public charity. The donor earns the same tax deduction as a direct gift — the most favorable allowed by the IRS — and can later recommend charitable distributions from it. That fund can bear the family name, but the family doesn’t have to manage it. Instead, the administering organization processes all gifts into the fund and invests them. The business owner then advises on where distributions go. There is no excise tax on earnings and no 5 percent distribution requirement. It’s also possible to take time before deciding where to send the money, which allows time for the money to grow, giving the donor’s charities more dollars in the end.
Donor-advised funds are also a better choice for those who want to remain quiet in their giving. Since the assets are held by an administering organization, the distributions made from donor-advised funds can be kept anonymous, both publicly and to the nonprofits they support, if preferred.
What types of organizations administer donor-advised funds?
Commercial entities are great if someone wants little personal contact and doesn’t mind their money residing in New York or Chicago. Community foundations are a better option for keeping charitable assets local while still having the option of supporting charities anywhere in the U.S. Fees are low and starting a fund is a quick, efficient process that can take as little as a day.
Insights Philanthropy is brought to you by Akron Community Foundation