Publicly Traded Securities

Publicly Traded Securities

Technical Report posted in Publicly Traded Securities on 2 May 2003| comments
audience: National Publication | last updated: 16 September 2012
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Abstract

Publicly traded securities are the most common form of noncash charitable gift asset. This paper reviews various types of publicly traded securities, discusses their suitability as a charitable gift assets and the unique rules that may apply to their transfer, reviews the rules concerning valuation for charitable contribution deduction purposes, and what constitutes delivery for federal tax purposes.

Introduction

Publicly traded securities are the most common form of noncash charitable gift asset. From the donor's standpoint, many types of publicly traded securities are attractive gift assets because they are often highly appreciated, are easily transferred, and, in most cases, can be readily valued for charitable contribution deduction purposes without the need for a qualified appraisal. Certain types, however, carry negative tax consequences that, in many cases, makes them unsuitable for transfer to charity.

The balance of this memorandum reviews various types of publicly traded securities and discusses their suitability as a charitable gift assets along with any unique rules that may apply to their transfer. Finally, we will review the rules concerning valuation for charitable contribution deduction purposes and what constitutes delivery for federal tax purposes.

Common and Preferred Stock

Common and preferred stock traded on a public exchange are the most common type of securities contributed to charity. Publicly traded stock is considered a capital asset as defined in IRC §1221. As such, stock that meets the minimum holding period requirement of one year qualifies as long-term capital gain property and can, thereby, be deducted for charitable income tax deduction purposes at its fair market value. The resulting deduction is subject to the 30% limitation. Stock that does not meet the minimum holding period requirement is considered ordinary income property with the charitable deduction based on the lesser of the donor's adjusted cost basis or fair market value of the stock on the date of contribution. The resulting deduction is subject to the 50% deduction limitation. The percentage limitation rules are discussed in Tax Review.

The fair market value of publicly traded stock is generally the mean between the highest and lowest quoted selling prices on the valuation date is the fair market value per share or bond. In any case where a dividend is declared on a share of stock before a charitable donation but is payable to stock holders of record on a date after the transfer, the stock is being transferred ex-dividend. In such case, the amount of the dividend is added to the ex-dividend quotation in determining the fair market value of the stock as of the date of transfer. Valuation rules are discussed in greater detail supra.

Mutual Funds

Like stocks, mutual funds are treated as capital assets for charitable contribution purposes and, if appreciated in value, make attractive charitable gift candidates.

The fair market value of a share in an open-end investment company ("mutual fund") is the public redemption price of a share. If there is no public redemption price quoted by the company for the applicable valuation date (e.g., the valuation date falls on a weekend or holiday), the fair market value of the mutual fund share is the last public redemption price quoted by the company for the first day preceding the applicable valuation date for which there is a quotation. In any case where a dividend is declared on a share in an open-end investment company before the transfer, but is payable to shareholders of record on a date after transfer, the share is quoted ex-dividend on the date of the date of transfer. In such cases, the dividend is added to the ex-dividend quotation in determining the fair market value of the share.1

In certain circumstances, taxes are withheld from mutual fund investments from all shareholders on a prorata basis. Tax-exempt shareholders are permitted to apply for a refund of these taxes.2

Closed-End Investment Companies

Unlike a mutual fund, a closed-end investment company does not continuously offer to buy back its shares at the option of its shareholders; nor does it continuously offer to sell its shares. After an initial sale by the company, the shares are traded in the secondary market like the shares of any other public corporation. The price per share fluctuates in relation to the value of the company's underlying portfolio and demand for its shares. Shares in a closed-end investment company trade in a manner similar to stock and are, therefore, valued in the same manner.

Restricted Securities

Some classes of stock cannot be traded publicly because of restrictions imposed by the Securities and Exchange Commission, by the corporate charter, or by trust agreement. Restricted securities generally include unregistered securities, investment letter stock, controlled stock, and private placement stock.

The general purpose of these restrictions is to protect the general public from the effect that trading by corporate insiders has on the value of securities and to permit a "cooling off" period whereby a full and fair disclosure of the character of the securities can be disseminated to the public.

Rule 144 of the Securities Act of 1933 defines persons who are "affiliates" or "control persons" of the issuer and thereby subject to sale restrictions and reporting requirements. The rule also defines persons who are "non-affiliates" and thereby exempt from the rule. Rule 145 deals with the sale of restricted securities that are acquired by means of merger or acquisition.

Affiliate Defined

Rule 144 defines an "affiliate" of an issuer as "a person that directly, or indirectly through one or more intermediaries, controls, or is controlled by, or is under common control with, such issuer. Furthermore, the term "person" when used with reference to a person for whose account securities are to be sold in reliance upon Rule 144 includes, "in addition to such person, all of the following persons:

  • Any relative or spouse of such person, or any relative of such spouse, any one of whom has the same home as such person;
  • Any trust or estate in which such person, or any relative described above collectively own ten percent or more of the total beneficial interest or of which any of such persons serve as trustee, executor or in any similar capacity; and
  • Any corporation or other organization (other than the issuer) in which such person or any relative described above are the beneficial owners collectively of ten percent or more of any class of equity securities or ten percent or more of the equity interest."

Application of Affiliate Status to Charitable Organizations

A charitable organization to which an outright gift of restricted stock is made is not an affiliate provided the organization does not own at least ten percent of the total outstanding shares. If, however, an affilate transfers shares to any trust (e.g., a charitable remainder trust or grantor charitable lead trust) in which the trustor retains a beneficial interest (retained income or reversionary) of at least ten percent of the amount transferred to the trust, the S.E.C. has stated informally that a charitable remainder trust in which the trustor/affiliate retains an income interest, the present value of which is at least ten percent of the amount transferred, is itself an "affiliate." A charitable remainder trust, therefore, in most cases cannot "wash" stock of its restricted status.

The rules further provide that sales by an affiliate trust are combined, for purposes of the Rule 144 sale limitations, with those of the trustor. An affiliate trust will retain its status as an affiliate as long as the trustor is considered an affiliate of the issuer, the S.E.C. stated. The S.E.C. has not issued any official opinion on the application of affilate status to charitable trusts. Neither has it issued any opinion regarding the classification of an organization to which a transfer of restricted stock is made in exchange for a charitable gift annuity. The latter may be distinguishable because it involves a non-trust transaction.

Sale Restrictions

Rule 144 imposes a minimum one-year holding period from the date the securities are acquired from the issuer or from an affiliate of an issuer. However, securities acquired from an affiliate of the issuer by gift shall be deemed to have been acquired by the donee when they were acquired by the issuer.

If restricted securities are sold for the account of an affiliate, the amount of securities sold, together with all sales of restricted or other securities of the same class for the account of such person within the preceding three months, shall not exceed the greater of:

  • one percent of the shares of the class outstanding;
  • the average weekly trading volume of such securities on all national exchanges during the four calendar weeks preceding the filing of Form 144 or, if not required, the date of receipt of the order to execute the trade; or
  • the average weekly trading volume of such securities as reported through a consolidated transaction reporting system.

Exemption for Non-Affiliates

The sale and filing requirements of the rule do not apply to restricted securities sold for the account of a person who is not an affiliate of the issuer at the time of the sale and has not been an affiliate during the preceding three months, provided a period of at least two years has elapsed since the latter of the date the securities were acquired from the issuer or from an affiliate of the issuer. If the securities were acquired by gift, the two-year period begins on the date the affiliate/donor acquired the securities from the issuer.

Valuation for Restricted Securities for Charitable Contribution Income Tax Deduction Purposes

Under the substantiation rules of Treasury Reg. §1.170A-13(c), a taxpayer making a contribution of publicly traded securities is not generally required to obtain a qualified appraisal to determine their value. If, however, the securities are subject to any restrictions that materially affect their value to the donor or prevent the securities from being freely traded, the taxpayer is required to obtain a qualified appraisal. Several methods of valuation are described in Rev. Rul. 77-287.3

In Ltr. Rul. 9320007 the Service ruled that restricted stock for which there was, due to the holding period and amount transferred, no restriction on its subsequent sale by the charitable donee, was qualified stock under section 170(e)(5)(B). Although not specifically enumerated in the ruling, the fact that the stock was stock for which market quotations were available, it suggests that no appraisal would be required to substantiate its value for charitable contribution deduction purposes.

In separate rulings the Service has also held that, (a) restricted securities are not considered qualified stock if the securities cannot be sold at the time of contribution due to holding period requirements, and (b) an individual's initial gift of restricted securities to a charitable remainder trust will not constitute a prohibited act of self-dealing if the individual's status as a disqualified person arises solely as a result of his contribution to the trust.4

Stock Subject to Right of First Refusal

In Rev. Rul. 80-83, a transfer of stock of a publicly held corporation subject to a first right of refusal by the corporation to a charitable remainder unitrust which named the trustor as trustee qualified for a charitable gift tax deduction under IRC §2522.5 The right required any shareholder desiring to sell stock to first offer the shares to the corporation at the same price and terms as offered to any other buyer. Such agreements should be reviewed to confirm that a transfer to charity is permitted.

Real Estate Investment Trusts

A real estate investment trust (REIT), as defined in IRC §856, may or may not be a suitable gift asset to a charitable entity because it may produce unrelated business income or may be prohibited from being owned by such an entity. Refer to the prospectus of the REIT under consideration.

Publicly Traded Master Limited Partnerships

Master limited partnerships (MLPs) may or may not be a suitable contribution asset to a charitable entity. Under prior law, for partnerships acquired after December 17, 1987, the gross income from such partnership interests was treated as unrelated business income to the tax-exempt partner regardless of the nature of the underlying income. Section 13145(a)(1) of the Revenue Reconciliation Act of 1993, however, repeals IRC §512(c)(2)(A). Therefore, MLP distributions are subject to the same classifications as other types of partnerships. The transfer of an MLP to a charitable remainder trust should be considered only after a thorough examination of the partnership prospectus and with specific attention given to possible unrelated business income from acquisition indebtedness or the partnership's business activities.

Options and Futures Contracts

Listed options are options to which the mark-to-market rules apply. They are referred to technically as Section 1256 Contracts and include all listed equity and non-equity options (including stock index futures and foreign currency contracts).

The holding period for such contracts is irrelevant for charitable contribution income tax deduction purposes. All gains and losses from section 1256 contracts must be reported annually according to the 60-40 Rule. Gains and losses are allocated 60% to long-term capital gain or loss and 40% to short-term capital gain or loss. Accordingly, a charitable contribution of such contracts will trigger application of the reduction rules applicable to the short-term capital gain (ordinary income) element.

A listed option may be a suitable asset for transfer to a charitable remainder trust or charitable lead trust provided the trustee does not intend to hold it for investment purposes. Such contracts have been identified as being a potential jeopardizing investment under IRC §4944.

Debt Instruments

Debt instruments such as U.S. Treasury obligations, mortgage-backed securities, municipal obligations, and corporate obligations that, if sold by the donor, would produce capital gain may be suitable candidates for charitable giving. There are two types of debts instruments, however, that produce reduced income tax benefits when contributed to charity or that may not be suitable for contributed at all.

Original Issue and Market Discount Obligations

Commonly referred to as "zero coupon bonds" IRC sections 1271 through 1275 deal with the income tax rules associated with OIDs and market discount obligations. The specifics are beyond the scope of this treatise; however, the relevant point is that these instruments often produce ordinary income on sale or redemption. The ordinary income element is not deductible; however, neither is it recognized on transfer of the bond to charity and subsequent sale.

U.S. Savings Bonds

If Series E, EE, H, or HH savings bonds are transferred to charity during life, the donor may claim a charitable contribution deduction for their fair market value. However, all unrealized income will be taxed to the trustor on the date of contribution.6 This restriction makes savings bonds generally inappropriate for transfer during the lifetime of the donor; however, such bonds may be transferred on a testamentary basis without recognition of income by the decedent or charity.

Date of Delivery

Many donors have made year-end contributions of securities assuming the contribution was complete only to find that the securities were actually delivered and, therefore, the gift made in the following tax year. The date on which a delivery of securities is considered complete depends on whom the securities are delivered by and to whom they are delivered.

Securities Physically Delivered to Charity by Donor

If a donor, donor's agent, or donor's broker physically delivers securities to the charity, the transfer is considered complete on the date the endorsed certificate (or the certificate and executive assignment form) is delivered.

Securities Delivered to Charity by Mail

If properly endorsed securities are mailed to the charity, charity's agent, or broker by the donor, donor's agent, or broker, delivery is considered complete on the date of mailing provided they are received by the charity in the ordinary course of the mails.

Securities Reissued in Charity's Name

If the donor delivers the stock certificate to his or her bank or broker (acting as the donor's agent), to the issuing corporation or its agent, for transfer into the name of the donee, the gift is complete on the date the stock is transferred on the books of the corporation. 7

Securities Held in Street Name

Many brokerage accounts hold securities in "street name." This means that although the securities posted to the account of the client, they are technically owned by the brokerage firm. In such cases, the client will instruct his or her broker to transfer securities from his account into the account of the charity. The delivery date is the date on which the brokerage firm transfers title

In this case, it is important to note that a transfer is not made at the time that instructions to transfer the shares are given to the donor's agent (broker or banker); rather, it is the date on which the transfer is made on the books of the issuing corporation. When contemplating a year-end transfer, one must take care to provide adequate time for this to occur or run the risk that the transfer is actually completed in the following tax year.

Valuation of Publicly Traded Securities

The following rules governing the valuation of stocks and bonds are provided in regulation sections 20.2031-2 and 25.2512-2. In general, the value of stocks and bonds is the fair market value per share or bond on the applicable valuation date. If there is a market for stocks or bonds, on a stock exchange, in an over-the-counter market, or otherwise, the mean between the highest and lowest quoted selling prices on the valuation date is the fair market value per share or bond.

If there were no sales on the valuation date but there were sales on dates within a reasonable period both before and after the valuation date, the fair market value is determined by taking a weighted average of the means between the highest and lowest sales on the nearest date before and the nearest date after the valuation date. The average is weighted inversely by the respective numbers of trading days between the selling dates and the valuation date.

If the stocks or bonds are listed on more than one exchange, the records of the exchange where the stocks or bonds are principally dealt in should be employed if such records are available in a generally available listing or publication of general circulation. In the event that such records are not so available and such stocks or bonds are listed on a composite listing of combined exchanges available in a generally available listing or publication of general circulation, the records of such combined exchanges should be employed. In valuing listed securities, the executor should be careful to consult accurate records to obtain values as of the applicable valuation date. If quotations of unlisted securities are obtained from brokers, or evidence as to their sale is obtained from officers of the issuing companies, copies of the letters furnishing such quotations or evidence of sale should be attached to the return.

If it is established with respect to bonds for which there is a market on a stock exchange, that the highest and lowest selling prices are not available for the valuation date in a generally available listing or publication of general circulation but that closing selling prices are so available, the fair market value per bond is the mean between the quoted closing selling price on the valuation date and the quoted closing selling price on the trading day before the valuation date. If there were no sales on the trading day before the valuation date but there were sales on a date within a reasonable period before the valuation date, the fair market value is determined by taking a weighted average of the quoted closing selling price on the valuation date and the quoted closing selling price on the nearest date before the valuation date. The closing selling price for the valuation date is to be weighted by the number of trading days between the previous selling date and the valuation date. If there were no sales within a reasonable period before the valuation date but there were sales on the valuation date, the fair market value is the closing selling price on such valuation date. If there were no sales on the valuation date but there were sales on dates within a reasonable period both before and after the valuation date, the fair market value is determined by taking a weighted average of the quoted closing selling prices on the nearest date before and the nearest date after the valuation date. The average is to be weighted inversely by the respective numbers of trading days between the selling dates and the valuation date. If the bonds are listed on more than one exchange, the records of the exchange where the bonds are principally dealt in should be employed. In valuing listed securities, the executor should be careful to consult accurate records to obtain values as of the applicable valuation date.

The application of these rules may be illustrated by the following examples:

Example (1). Assume that sales of X Company common stock nearest the valuation date (Friday, June 15) occurred two trading days before (Wednesday, June 13) and three trading days after (Wednesday, June 20) and on these days the mean sale prices per share were $10 and $15, respectively. The price of $12 is taken as representing the fair market value of a share of X Company common stock as of the valuation date [(3 x 10) + (2 x 15)]/5.

Example (2). Assume the same facts as in example (1) except that the mean sale prices per share on June 13, and June 20 were $15 and $10, respectively. The price of $13 is taken as representing the fair market value of a share of X Company common stock as of the valuation date [(3 x 5) + (2 x 10)]/5.

Example (3). Assume the decedent died on Sunday, October 7, and that Saturday and Sunday were not trading days. If sales of X Company common stock occurred on Friday, October 5, at mean sale prices per share of $20 and on Monday, October 8, at mean sale prices per share of $23, the price of $21.50 is taken as representing the fair market value of a share of X Company common stock as of the valuation date [(1 x 20) + (23 x 1)]/2.

Example (4). Assume that on the valuation date (Tuesday, April 3, 1973) the closing selling price of a listed bond was $25 per bond and that the highest and lowest selling prices are not available in a generally available listing or publication of general circulation for that date. Assume further, that the closing selling price of the same listed bond was $21 per bond on the day before the valuation date (Monday, April 2, 1973). Thus, under paragraph (b)(2) of this section the price of $23 is taken as representing the fair market value per bond as of the valuation date (25 + 21)/2.

Example (5). Assume the same facts as in example (4) except that there were no sales on the day before the valuation date. Assume further, that there were sales on Thursday, March 29, 1973, and that the closing selling price on that day was $23. The price of $24.50 is taken as representing the fair market value per bond as of the valuation date [(1 x 23) + (3 x 25)]/4.

Example (6). Assume that no bonds were traded on the valuation date (Friday, April 20). Assume further, that sales of bonds nearest the valuation date occurred two trading days before (Wednesday, April 18) and three trading days after (Wednesday, April 25) the valuation date and that on these two days the closing selling prices per bond were $29 and $22, respectively. The highest and lowest selling prices are not available for these dates in a generally available listing or publication of general circulation. Thus, under paragraph (b)(2) of this section, the price of $26.20 is taken as representing the fair market value of a bond as of the valuation date [(3 x 29) + (2 x 22)]/5.

Determining Value Based on Bid and Asked Prices

If prices are determined based on bid and asked prices, the fair market value may be determined by taking the mean between the bona fide bid and asked prices on the valuation date, or if none, by taking a weighted average of the means between the bona fide bid and asked prices on the nearest trading date before and the nearest trading date after the valuation date, if both such nearest dates are within a reasonable period. The average is to be determined in the manner described in the previous examples.

Determining Value Based on Incomplete Selling Prices or Bid and Asked Prices

If the provisions of previous paragraphs are inapplicable because no actual sale prices or bona fide bid and asked prices are available on a date within a reasonable period before the valuation date, but such prices are available on a date within a reasonable period after the valuation date, or vice versa, then the mean between the highest and lowest available sale prices or bid and asked prices may be taken as the value.

Determining Value Where Selling Prices or Bid and Asked Prices Do Not Reflect Fair Market Value

If it is established that the value of any bond or share of stock determined on the basis of selling or bid and asked prices as provided above does not reflect the fair market value thereof, then some reasonable modification of that basis or other relevant facts and elements of value are considered in determining the fair market value. Where sales at or near the date of death are few or of a sporadic nature, such sales alone may not indicate fair market value. In certain exceptional cases, the size of the block of stock to be valued in relation to the number of shares changing hands in sales may be relevant in determining whether selling prices reflect the fair market value of the block of stock to be valued. If the executor can show that the block of stock to be valued is so large in relation to the actual sales on the existing market that it could not be liquidated in a reasonable time without depressing the market, the price at which the block could be sold as such outside the usual market, as through an underwriter, may be a more accurate indication of value than market quotations. Complete data in support of any allowance claimed due to the size of the block of stock being valued shall be submitted with the return. On the other hand, if the block of stock to be valued represents a controlling interest, either actual or effective, in a going business, the price at which other lots change hands may have little relation to its true value.

Determining Value When Selling Prices or Bid and Asked Prices are Unavailable

If the provisions of the previous paragraphs are inapplicable because actual sale prices and bona fide bid and asked prices are lacking, then the fair market value is to be determined by taking the following factors into consideration:

  • In the case of corporate or other bonds, the soundness of the security, the interest yield, the date of maturity, and other relevant factors; and
  • In the case of shares of stock, the company's net worth, prospective earning power and dividend-paying capacity, and other relevant factors.

Some of the "other relevant factors" referred to in the subparagraphs include the good will of the business; the economic outlook in the particular industry; the company's position in the industry and its management; the degree of control of the business represented by the block of stock to be valued; and the values of securities of corporations engaged in the same or similar lines of business which are listed on a stock exchange. However, the weight to be accorded such comparisons or any other evidentiary factors considered in the determination of a value depends upon the facts of each case. In addition to the relevant factors described above, consideration shall also be given to nonoperating assets, including proceeds of life insurance policies payable to or for the benefit of the company, to the extent such nonoperating assets have not been taken into account in the determination of net worth, prospective earning power and dividend-earning capacity. Complete financial and other data upon which the valuation is based should be submitted with the return, including copies of reports of any examinations of the company made by accountants, engineers, or any technical experts as of or near the applicable valuation date.


Copyright 2009. Marc D. Hoffman. All rights reserved. Used by permission.

  1. Reg. §20.2031-8(b)(1); U.S. v. Cartright (1973), 411 U.S. 546, 31 AFTRback

  2. Rev. Rul. 66-200, 1966-2 C.B. 518back

  3. Rev. Rul. 77-287, 1977-2 C.B. 319; See also Ltr. Ruls. 9623018 and 9247018.back

  4. Ltr. Ruls. 9247018 and 9435007.back

  5. Rev. Rul. 80-83back

  6. Ltr. Rul. 8010082back

  7. Reg. §1.170A-1(b)back

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