Historically, S corporations were at a disadvantage compared to partnerships and LLCs when it came to charitable contributions of appreciated property.  Congress leveled the playing field, but only temporarily, in 2006.  Now, with this provision having expired at the end of last year, S corporation shareholders once again face situations where they may not realize the full benefit of the charitable deduction from these contributions.

Background

Prior to 2006, an S corporation shareholder’s stock basis was reduced by his pro-rata share of the fair market value (FMV) of appreciated property contributed to charity.  This treatment could lead to situations whereby the S corporation shareholder would not be able to deduct the FMV of the charitable contribution due to basis limitation provisions.  Contrast this result with the treatment for partners in a partnership.  Specifically, Rev. Rul. 96-11 allows a partner to reduce his partnership basis by the adjusted basis (rather than the FMV) of the contributed property.

In response to this disparity, the Pension Protection Act of 2006 effectively changed S corporation shareholders’ basis adjustment for charitable contributions of appreciated property to be based upon the shareholders’ pro rata share of the S corporation’s adjusted basis in the contributed property as opposed to the FMV of such property.  This change essentially brought the treatment of S corporation shareholders in line with partners in a partnership.  This temporary provision has been extended multiple times, most recently by the American Tax Relief Act of 2012.

Without further legislative action, this rule regarding the basis decrease resulting from a charitable contribution of appreciated property by an S corporation does not apply to contributions made in tax years beginning after December 31, 2013.  Thus, for contributions of appreciated property made in tax years beginning after December 31, 2013, the shareholders’ stock basis will be reduced by the shareholders’ pro-rata share of the FMV of the contribution.

Discussion

To illustrate the impact of this expired provision, consider the following examples contrasting the stock basis reduction rules as noted for calendar tax years 2006 - 2013 versus the 2014 calendar tax year and forward (pending any legislative changes).

Example (stock basis reduction 2006 - 2013): Assume that A is a 100% shareholder in an S corporation and has a basis of $40,000 in his S corporation stock at the beginning of the year. The S corporation contributes long-term capital gain property in 2013 with a basis of $30,000 and a fair market value of $60,000 to a charity.  The shareholder may take a full $60,000 charitable contribution deduction as his S corporation stock basis is only reduced from $40,000 to $10,000.

Example (stock basis reduction 2014): Assume the same facts as above, except that the charitable contribution is in 2014. The shareholder may take only a $40,000 charitable contribution deduction (with a $20,000 basis limitation loss carryover to the next year) as his basis in his S corporation stock has been reduced from $40,000 to $0.

The following table summarizes the varying results from the two examples noted above:

As one can see from the table, assuming that there is no other corporate activity and the corporation dissolves with no liquidating distributions to the shareholder, the shareholder would have an additional capital loss of $10,000 in 2006 - 2013 versus $0 in 2014.  The difference between the total deductions/losses taken of $30,000 (i.e., $60,000 + $10,000 = $70,000 for 2006 - 2013 compared to $40,000 for 2014) between the two scenarios represents the benefit that a shareholder received of making the charitable contribution of appreciated property during the 2006 - 2013 tax years as compared to the 2014 tax year.

Planning & Conclusion

To the extent that an S corporation has made charitable contributions of appreciated property for tax years beginning after January 1, 2006 and before January 1, 2014, if the charitable contribution deduction and related stock basis decrease was not treated properly refund opportunities may exist for open tax years.  Furthermore, even if refund opportunities are not available due to the statute of limitations having expired, one may want to consider at least adjusting the shareholders’ stock tax basis schedules to properly reflect the “basis reduction” as opposed to FMV for the charitable contribution of appreciated property.

With regards to 2014, if an S corporation has already made a charitable contribution of appreciated property, discuss the current status of the basis adjustment with the tax return preparer and take into consideration any basis limitations of such charitable contribution. The shareholders’ 2014 estimated tax payments may need to be adjusted to reflect basis limited charitable contribution deductions.

For S corporations considering making a 2014 charitable contribution of appreciated property, one may want to consider delaying such contribution.  Congress may take legislative action to extend the “basis reduction” approach, but until they do so (if ever), caution should be taken when an S corporation is considering making a charitable contribution of appreciated property.  For those who keep a scorecard of the pros and cons of S corporations versus partnerships and LLCs (even though they are both flow-through entities), if Congress does not take action to extend the “basis reduction” provision for the contribution of appreciated property for S corporations, mark this topic as a con for S corporations.

If your S corporation has recently donated, or is contemplating the donation of appreciated property to charity, consult your local CBIZ MHM tax professional to discuss the implications.

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