Plan to Avoid Gain on Sale of Company by Donating Shares to Charity Goes Awry

(Parker Tax Publishing April 2023)

The Tax Court held that a taxpayer who contributed shares of stock in a closely held corporation to a charitable organization near-contemporaneously with the selling of those shares to a third party realized and recognized gain under the anticipatory assignment of income doctrine. The court also found that the taxpayer was not entitled to a charitable deduction for the donated shares because he failed to attach a qualified appraisal to his tax return. Estate of Hoensheid v. Comm'r, T.C. Memo. 2023-34.

Background

Commercial Steel Treating Corp. (CSTC) is a company that manufactures heat-treating metal fasteners for use in automobiles and other commercial vehicles. As of January 1, 2015, CSTC was owned in equal shares by Scott Hoensheid and his two brothers, Craig Hoensheid and Kurt Hoensheid. In 2014, the Hoensheid brothers decided to sell CSTC. They considered $80 million to be a fair target price. CSTC engaged FINNEA Group as its financial adviser in connection with the sale. Brian Dragon, senior managing director of FINNEA, was the main collaborator for CSTC.

On April 1, 2015, a private equity firm called HCI Equity Partners (HCI) submitted a letter of intent to acquire CSTC. On April 23, HCI, CSTC, and the Hoensheid brothers executed a nonbinding letter of intent, establishing the parties' mutual interest in HCI's acquisition of CSTC for $107 million. At that time, HCI began the process of conducting due diligence into CSTC's business and financial operations.

In April 2015, Scott began discussing the prospect of establishing a donor-advised fund with Fidelity Charitable Gift Fund (Fidelity Charitable) to make a presale charitable contribution of some of his CSTC stock with his wealth advisers, Richard Balamucki and Casey Bear, and Andrea Kanski, his longtime tax and estate planning attorney at Clark Hill PLC. In an email to John Hensien, another attorney at Clark Hill, Kanski mentioned that Scott was considering donating some of his CSTC stock to charity "to avoid some capital gains" and noted that "the transfer would have to take place before there is a definitive agreement in place."

On June 11, 2015, CSTC held its annual shareholders meeting, at which the Hoensheid brothers voted to approve the sale to HCI. Craig and Kurt also approved Scott's request to transfer a portion of his stock to Fidelity Charitable, but the number of shares to be transferred was not specified. At some point after June 11, Scott had a stock certificate partially prepared for the eventual transfer to Fidelity Charitable. He kept the incomplete stock certificate in his office desk until July 9 or 10, 2015, when he dropped it off at Kanski's office.

On June 30, 2015, HCI's due diligence was completed and a report was issued indicating potential environmental liability issues arising out of CSTC's existing facilities. Several important events occurred in early July 2015 in advance of the closing of the sale. On July 6, HCI organized a holding company, CSTC Holdings, Inc., for the purpose of acquiring shares of CSTC. On July 7, Scott wrote in an email discussing a plan for CSTC to "sweep the cash from the company prior to closing and distribute it to the brothers." As of that date, CSTC and Scott took action to trigger bonus payouts consistent with the plan to sweep CSTC's cash before closing. On July 10, CSTC paid out $6.1 million in employee bonuses and, a few days later, on July 14, distributed $4.7 million to Scott and his two brothers as shareholders. Fidelity Charitable did not participate in the July 14 shareholder distribution.

On July 10, the environmental liability issue identified in HCI's due diligence report was resolved via an indemnification provision. Additionally, on July 10 CSTC amended its Articles of Incorporation to allow certain actions to be approved by written shareholder consent - a change requested by HCI. On July 13, Bear received a PDF stock certificate from Kanski, which he forwarded to a representative of Fidelity Charitable. The stock certificate was signed by Scott and stated that 1,380 shares of CSTC stock were owned by Fidelity Charitable. The sale of CSTC closed on July 15, 2015. On that date, Fidelity Charitable sold the 1,380 CSTC shares for $2.9 million, the proceeds of which were deposited into Scott's giving account.

Kanski supervised the preparation of Scott's 2015 federal income tax return. On the return, Scott reported no capital gains with respect to the shares he donated to Fidelity Charitable. He also claimed a noncash charitable contribution deduction of $3,282,511 with respect to the donated shares. Included with Scott's return was a Form 8282, Donee Information Report, reporting the receipt of Scott's CSTC shares on June 11, 2015. Also included was an appraisal prepared by Dragon.

The IRS disallowed Scott's charitable contribution deduction and determined a deficiency and applied a penalty under Code Sec. 6662(a). Scott took his case to the Tax Court. Scott passed away in 2022, and his estate was substituted as a party.

Analysis

In Humacid v. Comm'r, 42 T.C. 894 (1964), the Tax Court set forth a two-part test for determining whether to respect the form of a charitable contribution of appreciated property followed by a sale by the donee. The donor must (1) give the appreciated property away absolutely and divest of title (2) "before the property gives rise to income by way of a sale." The first prong incorporates the requirement under Code Sec. 170(c) that the taxpayer make a valid gift of property, while the second prong incorporates the anticipatory assignment of income doctrine. Under the anticipatory assignment of income doctrine, a donor is treated as having effectively realized income and then assigned that income to another when the donor has an already fixed or vested right to the unpaid income.

The IRS argued that the anticipatory assignment of income doctrine applied because Scott's right to the income from the CSTC shares was fixed as of the date of the gift of the stock to Fidelity Charitable. Scott disagreed, arguing that his gift of the shares to Fidelity Charitable was completed on June 11, 2015, while the transaction with HCI was still being negotiated up until the closing on July 15. According to Scott, he and HCI "basically negotiated right up until the day before we closed."

The Tax Court held that Scott recognized gain on the sale of the CSTC shares he donated to Fidelity Charitable under the anticipatory assignment of income doctrine.

Applying the first prong of the Humacid test, the court upheld the validity of Scott's gift of shares to Fidelity Charitable. However, it rejected Scott's contention that the gift occurred on June 11 because it found no specific action taken on that date that placed the shares within Fidelity Charitable's dominion and control. In the court's view, the strongest evidence of the shares leaving Scott's dominion and control was Bear's July 13, 2015 email of the PDF stock certificate to Fidelity Charitable, which provided Fidelity Charitable with an instrument that it could present to CSTC and exercise its rights as shareholder. The court therefore concluded that delivery of the shares did not occur before July 13, 2015.

Next, the court found that, as of July 13, 2015, the sale of CSTC to HCI was virtually certain to occur and Scott's right to income from the shares was fixed as of that date. The most significant evidence, in the court's view, was the "cash sweeping" actions taken by CSTC. The court reasoned that it was highly improbable that the Hoensheid brothers would have emptied CTSC of its working capital if the transaction had even a small risk of not consummating. While the July 14 distribution took place the day after the gift, the court found that the decision to make the distribution had already been made as of that date. The court noted that the bonus payouts and distributions were not in any way contingent on the final execution of the purchase agreement. The court also pointed out that, once made, the bonus payouts and distributions could not be clawed back and had tax consequences on receipt for the participating employees and shareholders, including Scott.

In the court's view, Scott's characterization of the transaction as still being negotiated up until the closing was not borne out by the facts. The court noted that certain compensation and real estate issues appeared to have been resolved in drafts of the purchase agreement prepared before July 13, 2015. The court also pointed out that on July 10, 2015, HCI's counsel prepared a draft with a new seller indemnity provision addressing the environmental liability issue.

Observation: The court explained that it was not specifying a bright line for donors to stop short of in structuring charitable contributions of appreciated stock before a sale. However, the court took note of Kanski's advice to Scott that "any tax lawyer worth her fees would not have recommended that a donor make a gift of appreciated stock" so close to the closing of a sale. The court remarked that by July 13, 2015, the transaction with HCI had simply "proceeded too far down the road" to enable Scott to escape taxation on the gain attributable to the donated shares.

The court determined that Scott was not entitled to a deduction for his gift of shares to Fidelity Charitable because he failed to comply with the requirements of Code Sec. 170(f)(11) to attach a qualified appraisal to his return.

The court, however, held that Scott was not liable for a Code Sec. 6662(a) penalty because, even though Kanski's advice on an issue of substantive tax law (i.e., that the execution of the definitive purchase agreement was the firm deadline to contribute the shares and avoid capital gains) was wrong, Scott reasonably relied on her advice.

For a discussion of the anticipatory assignment of income doctrine, see Parker Tax ¶70,105. For a discussion of the substantiation of noncash charitable contributions of more than $500,000, see Parker Tax ¶84,190. For a discussion of abatement of penalties due to reasonable cause, see Parker Tax ¶262,127.

Disclaimer: This publication does not, and is not intended to, provide legal, tax or accounting advice, and readers should consult their tax advisors concerning the application of tax laws to their particular situations. This analysis is not tax advice and is not intended or written to be used, and cannot be used, for purposes of avoiding tax penalties that may be imposed on any taxpayer. The information contained herein is general in nature and based on authorities that are subject to change. Parker Tax Publishing guarantees neither the accuracy nor completeness of any information and is not responsible for any errors or omissions, or for results obtained by others as a result of reliance upon such information. Parker Tax Publishing assumes no obligation to inform the reader of any changes in tax laws or other factors that could affect information contained herein.

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