Case of the Week

Case:

Barbara Banker started with nothing. She lived in a mid-sized town and worked in the local hardware store.  The store owner noticed her industrious efforts and strong work ethic. When he decided to retire, he suggested Barbara take over the hardware store and pay him from store profits over a term of 10 years. Barbara did exactly that. When the town drugstore owner wanted to retire, Barbara bought the store under a similar plan. Later, Barbara started buying apartment buildings in town. Because she needed financing for these purchases, Barbara became good friends with the town bankers. 

Two bankers approached Barbara about starting a new local bank. She agreed to be one of the initial directors and all three invested in the bank, which they named LoBank. Over the years, the bank’s services and value greatly increased. Barbara is a respected executive and owns a large block of LoBank stock.

As a strong community supporter, Barbara gives regularly to her favorite local charity. She would like to make a large gift of bank stock to a local charity for a new youth center. As a director she knows that LoBank’s directors have approved signing a letter of intent for the sale of all of LoBank’s stock to MegaBank. Barbara met with her counsel to discuss the gift.

Question:

Barbara explained, “My favorite charity has a naming opportunity for the new youth center and has asked if I would consider making the lead gift. I am interested in supporting youth, and this center would be a fine addition to our town. The LoBank stock has significantly increased in value, but I have heard that there may be problems with this gift now that there is a letter of intent. Can I still make this gift?”

Solution:

Barbara’s counsel explained that it is possible to make a gift of LoBank stock at this time. After negotiations, the next step in the C corporation sale process is to sign a letter of intent. The letter of intent is negotiated and deemed acceptable by both buyer and seller. It normally does not require specific actions by either party. Rather, the letter of intent is a description of the proposed sale arrangement.

In Gerald A. Rauenhorst, et. aux. v. Commissioner; 119 T.C. No. 9; No. 1982-00 (7 Oct. 2002), the court noted, "[T]he letter of intent was not an offer; it was neither a purchase, tender, or exchange offer as the antidilution provision specifies." The Rauenhorst court stated that the letter of intent and the resolution accepting the letter of intent did "not demonstrate that the warrant holders were legally bound, or could be compelled, to sell their stock warrants at the time of the assignments."

With a typical letter of intent, there is a description of the proposed sale transaction, but neither party is legally bound to complete the agreement. Thus, there is no Rev. Rul. 78-197 binding agreement that would preclude the bypass of gain on a subsequent transfer of the stock to charity. While the transaction must still be carefully reviewed to ensure it is not part of a prearranged sale, the existence of an letter of intent alone does not automatically trigger recognition of gain. Because Barbara does not have a binding agreement to sell prior to making a charitable gift, she may make the gift, bypass the capital gain and deduct the appraised value. Her charitable deduction limit will be 30% of her adjusted gross income because the stock is an appreciated asset. If she cannot use the full deduction amount due to the 30% limit, Barbara may carry forward the remaining deduction for up to five additional years.