Charitable contributions of closely held stock.

• Author: Gillis, Michael R.

There are certain situations for closely held corporations and their shareholders when the use of a "charitable bailout" can be beneficial.

A charitable bailout occurs when a shareholder contributes stock in another closely held corporation to a charity and that stock is later redeemed from the charity by the corporation.

Taxpayers have long relied on--and the IRS has accepted--the Tax Court decision in Palmer, 62 TC 684 (1984). In Palmer, the taxpayer had voting control of both a corporation and a tax-exempt private foundation. The taxpayer donated shares of the corporation's stock to the foundation, and the corporation redeemed the stock from the foundation.

The Service took the position that the substance of the transaction was a redemption of stock from the taxpayer, followed by a gift of the proceeds to the foundation. The Tax Court rejected this argument and treated the transaction according to its form. The court held that the transfer of the stock to the foundation was a valid gift, and the redemption of the stock by the corporation did not result in income to the donor.

In Rev. Rul. 78-197, the IRS stated that it would follow the court's decision in Palmer so long as there was no legal obligation requiring the charity to sell the stock back to the corporation. Even if there is an informal understanding that the stock will be redeemed from the charity, the form of the transaction will be followed, as long as there is no legal requirement for the charity to sell the shares.

These charitable bailouts can have considerable tax advantages. With individual tax rates higher than corporate rates, the charitable deduction could mean more to the shareholder than to the corporation. This also can reduce concern about excess accumulated earnings inside a corporation and serve as a method of reducing a shareholder's estate (by removing the value of the contributed stock).

If the corporation has family member minority shareholders, the contribution of stock can shift more of the future appreciation to the second-generation family members.

The value of charitable bailouts was greatly increased by the Revenue Reconciliation Act of 1993's permanent repeal of the alternative minimum tax (AMT) add-back for the charitable contribution of appreciated property. These transactions often involve low-basis stock that is substantially appreciated, and the AMT add-back negated the benefits by causing the shareholder to pay AMT.

The use of a charitable...