One of the concerns about the “estate donation” rules when they were introduced in 2016 is illiquid property would be harder to donate and administer. Perhaps the most challenging type of illiquid property is private company shares. Five years of experience with the system has validated some concerns and produced planning solutions.
The “estate donation” rules, which were introduced alongside the graduate rate estate regime, are a significant departure from the pre-2016 rules.
Previously, a gift by will was deemed to have occurred immediately before the date of death. Legally, it was a lifetime gift, claimed on the final two lifetime tax returns. The timing coincided with the deemed disposition of capital property. Hence, a tax credit from the donation would align with the tax liability in the final year. The old system allowed a terminal T1 – the final lifetime return – to be filed with the donation even though the property had not been transferred to charity.
If the property was private shares, and the intent was to sell this property and donate cash to charity, the old system was forgiving. The executor could file and reduce the tax liability without selling the illiquid property.
Estate Donations – Post 2016
The “estate donation” rules shifted the gift by will to a gift of the estate for tax purposes. The deemed disposition rule still applies but the offsetting tax credit is not available until the property is transfer and tax receipt is issued.
If the gift is not made prior to the filing of the terminal T1 the estate can have a significant immediate tax bill. Once donation receipts are filed the tax can be recovered. While it may only be a timing issue, there is a cost. This system is positive for charities because it produces an incentive for the executor to administer and distribute faster. Some property, however, can’t be sold immediately.
The post-2016 rules incent the executor to distribute complex property in kind to the charity. The charity then has the responsibility to administer and sell the property, but that requires a knowledgeable charity and strong working relationship with the executor and company. Very few registered charities have the capacity to handle donations of private company shares. This isn’t a failing, merely a question of priorities and expertise.
One solution is to name a public foundation with donor advised funds as the recipient of private shares. Assuming the public foundation has the policies, processes, and expertise to handle these assets, it can address the tax mismatch and administration issues. A donor advised fund also allows future grants to a wide variety of charities. It’s a viable solution to an increasingly common estate donation issue.