Act fast to use a donation to avoid an inversion’s tax bite

Shareholders of companies undergoing corporate inversions have a capital gains tax bill coming up, and merely donating the shares may not be the most bulletproof way to avoid the levy.
Corporate inversions have been in the news as U.S.-based companies try to duck corporate taxes as high as 35% stateside by expatriating to a foreign country. In such a deal, an American company merges with a smaller company that’s based in a nation with lower corporate tax. Recently announced deals include a transaction wherein medical technology company Medtronic Inc. of Minneapolis said it would merge with Covidien PLC of Dublin, Ireland. AbbVie Inc., a Chicago-based medical research firm, also announced a deal with Shire of Jersey in the U.K.
Inversions tend to result in higher tax bills for shareholders, as once a deal goes through, an investor with shares of the U.S.-based company is involuntarily swapping them for shares of the new foreign company, triggering a capital gains tax. It’s even worse if the shareholder has held onto the stocks for a long time and experienced a massive run-up in value. To mitigate that effect, tax experts have talked about potentially donating those shares to charitable organizations.
But with charitable donations of stock, particularly that of a company undergoing an inversion, shareholders need to time those gifts, otherwise they will end up facing the capital gains bite anyway.
The Internal Revenue Service’s take on the issue has been that as long as the recipient charity at the time of the donation isn’t legally bound to surrender the stock, then the Tax Man will respect the gift and the donor will avoid the capital gains tax, according to Richard L. Fox, partner at Dilworth Paxson, where he leads the philanthropic and nonprofit practice.
The IRS’ stance on such gifts ties back to what’s known as the “assignment of income” doctrine, which states that income is normally taxed on the person who earns it and that this taxation can’t be shifted by what the IRS calls “anticipatory assignments.” In this context, if the capital gains on that donated stock is a 100% certainty and the inversion deal that will make it happen is officially a go, then the tax belongs to the person making the donation, Mr. Fox said.
“Because you waited until the deal was fixed — there’s shareholder approval, there’s regulatory approval — there is no question that the charity will have to surrender the stock when it receives it,” Mr. Fox added. As a result, whatever cash the charity gets after surrendering the shares is treated as a charitable contribution, and the tax bill goes to the donor.
This is similarly the case with structuring a charitable remainder trust as the vehicle for the shares. “Charitable remainder trusts are an attractive vehicle, particularly to people with charitable inclinations and low-basis stock. You want to defer payment of gains and have some liquidity,” said Ronni Davidowitz, chair of the New York trusts and estate department at Katten Muchin Rosenman.
“The problem is that if you have a deal in the offing, you’re down certain paths and the capital gains realization will still be visited on the donor,” she said.
Want to make a donation without facing an accidental capital gains tax? Keep tabs on the inversion deal as it unfolds. Transfer the stock before the shareholders vote to approve the inversion, and retain evidence of when that vote took place so you have proof of when the donation occurred in the event of an IRS audit, Mr. Fox noted.
“As long as there are some things that have to be done in order to get the deal wrapped up, and it’s not just shuffling paper, you can take the position that it’s not a done deal,” he added.