Contribution of Appreciated Stock

TAX CASE

Owners of closely held corporations frequently contribute corporate stock to public charities or private foundations. The tax benefits from the contribution will vary greatly depending on whether the taxpayer can claim a deduction for the stock’s full value or whether the deduction is limited to the stock’s basis. Recently the Tax Court considered this issue.

In December 1994 John Todd contributed 6,350 shares of Union Colony Bancorp to a private foundation he had formed. He claimed a charitable contribution of $553,847. His basis in the stock was $33,338. Todd had based the stock value on the price in a sale of other shares around the same time he made the contribution.

Union Colony did not trade on an established market. Instead Gill & Associates, a member of the National Association of Securities Dealers, maintained a matching service for those who wanted to buy or sell shares of the company. Gill quoted a price to prospective customers upon request based on the corporation’s book value, which Gill believed was the equivalent of fair market value.

The IRS reduced Todd’s deduction to the stock’s basis. It argued that fair market value is available only if a stock is traded on an established market. And even if it was, the taxpayer failed to provide the required appraisal.

Result. For the IRS. The Tax Court first addressed the question of whether there were market quotations for the contributed stock on an established market. It concluded there were not. The fact an investment banking house maintained a matching service and was willing to quote book value did not constitute an established market. The limited number of sales proved the shares were not readily tradable. Congress enacted the deduction limit to prevent overstatement of contributions—this was the type of case that concerned it. The fact the taxpayer’s expert witness opined the broker’s actions created a market did not actually create one.

Although the court could have stopped at this point, it went on to address the absence of an appraisal. The regulations require the taxpayer to provide an appraisal for all gifts of property that are not traded on an established exchange. Todd failed to supply one and therefore would again be denied a deduction in excess of his basis. The court did not even discuss the fact the stock value was determined from a sale of other shares at the same time as the contribution.

Because of the significant potential for abuse, the courts strictly enforce the contribution rules. Deductions for gifts of stock to private foundations are limited to basis unless the stock trades on an established market, has a quoted market price and the taxpayer provides an appraisal. CPAs should encourage clients to follow the substantiation rules exactly. The fact the value of the gift can be proven by alternative means is insufficient.

John C. Todd v. Commissioner, 118 TC no. 334.

Prepared by Edward J. Schnee, CPA, PhD, Joe Lane Professor of Accounting and director, MTA program, Culverhouse School of Accountancy, University of Alabama at Tuscaloosa.