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Tuesday September 2, 2014

Case of the Week

George’s “Green” Sub S Gift On Hold

Case:

George Green was a man of humble beginnings. He was born in Bulgaria and lived with his parents on their farm. But George was a diligent student and was determined to become a successful business owner. After high school he obtained permission to come to America to go to college. George applied to several colleges and was accepted as a work-study student at a state college. He lived in the dorm and worked nights in the cafeteria. On weekends, he moonlighted as a waiter at a five-star restaurant.

George was both resourceful and determined to succeed. He enrolled in chemical engineering and studied every spare moment. His industry was quickly recognized by faculty. After graduating with honors, he became a graduate assistant and earned a master's degree in engineering.

George always loved nature. He accepted a position as a product development engineer with a company that built emissions control equipment for automobiles. Soon, George met Helen Wilson, and they married.

But he was too energetic to stay in one place. After saving $5,000, he convinced Helen that it was time for him to go out on his own. George started a company that offered environmental consulting. As soon as he could find the necessary funds, he started to produce components for emissions control equipment. After a terrific struggle, the business took off and George began to manufacture probes for company smokestacks. When asked if that was a good business, George responded, "It is a great business. Companies buy my probes to measure their smokestack emissions, and the government changes the rules! Then, they all have to buy upgraded probes!"

Later, George incorporated the probe manufacturer as Green Probe (GP). Based upon the advice of his CPA Clara White, he elected Subchapter S status for GP. George has been active in his local charities and recently accepted a position as Chair of the Board for a local environmental charity. Six years ago, George bought land for potential expansion of his plant for $100,000. Since another parcel is now more attractive, he does not need the land. But when the city built a new major roadway next to his property, the land value increased to $300,000.

Question:

Local charity is in the midst of a major capital campaign. George would like to support them, but asks CPA Clara, “What is the best way to make a major gift?”

Solution:

Clara thought for a moment and responded, “George, you have that property in GP that you no longer need for expansion. In fact, now that the city completed the adjacent road, you would not want to build a new plant in a developing commercial area. Why don’t you give local charity the land? You could receive a substantial deduction.”

As a subchapter S corporation owner, George has a basis in his stock, called the “outside basis.” But GP also has a basis in the land, or the “inside basis.” If a gift of appreciated property is made by GP, the charitable deduction flows through to George. In this case there is an adjustment of the outside basis of the stock held by George. Sec. 1367(a)(2).

However, Clara cautioned George about a pending tax change. Because the Senate has not yet passed the tax extenders this year, a gift of the $300,000 appreciated land would require a reduction in outside basis of the full $300,000. If the tax extenders are passed with the Subchapter S appreciated gifts provision before the end of the year, then the deduction flows through at fair market value, but the decrease in George’s outside basis is equal to the $100,000 adjusted basis of the gifted property to the Subchapter S corporation.

Therefore, GP placed the gift on hold. During the November lame duck session of Congress, it is quite likely that the tax extenders will be passed. At that time GP will make the gift. The GP inside basis is $100,000 and the fair market value is $300,000. If the tax extenders are passed, the $300,000 appreciated charitable deduction flows through to George and Helen, but their GP stock basis is reduced by only the $100,000 inside basis of the land. Since George and Helen have a GP stock basis of $155,000, their basis after the gift is reduced to $55,000.

George and Helen are very pleased with this plan. If the tax extenders pass, they will make a major gift, receive a $300,000 appreciated property charitable deduction and help the charity they both love.

Published August 29, 2014
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