Assignment of Income: Why Timing is Everything for your Tax Strategy

Unfortunately, many business owners may not think about generosity and charitable giving until the sales transaction from their business exit is past and their bank account is flush with cash. Although nonprofits may still appreciate your gifts, the ability to maximize your tax savings is too late.

With prior charitable & tax planning, you can turn your business sale into a tool that allows you to build a charitable legacy, achieve substantial tax savings, and have enough wealth left from your sale to enjoy the next steps in your life. To minimize Uncle Sam’s share, your strategy needs to be built into the business sale at the letter of intent stage, not the closing dinner.

This article will discuss the planning that goes into a tax-smart exit and the importance of watching out for the assignment of income trap.

Avoid the assignment of income trap

The Power of the “Pre-Sale”

Regardless if your business is structured as a C-corp or S-corp, the key is recognizing how to donate a portion of your private stock into a giving vehicle such as a private foundation, charitable lead trust (CLT), charitable remainder trust(CRT) or donor advised fund.

Timing is of absolute importance: this donation must occur before a purchase agreement is signed.

The Assignment of Income Trap

In tax law, there is a fundamental principle: Income is taxed to the person who earns it. You cannot simply "hand over" your paycheck to someone else and tell the IRS to tax them instead.

In the case of a  business sale, the "trap" occurs when a business owner tries to donate shares of their company to a charity or charitable vehicle after the sale is already "too far along."

Ideally, you want to donate shares before the sale. If done correctly:

1. You get a tax deduction for the full fair market value (FMV) of the shares.

2. You avoid capital gains tax on those shares because the charity/charitable vehicle sells them, and charities don't pay capital gains tax.

If the IRS decides the sale was a "done deal" before you made the gift, they will invoke the Anticipatory Assignment of Income doctrine. They will argue that you didn't really give away stock; you gave away the cash proceeds from a sale that had already effectively happened. This is the trap you want to avoid. Otherwise, you get taxed on the capital gains as if you sold the shares yourself. You lose the "tax avoidance" half of the strategy.

When Does the Trap Spring? (The "Ripeness" Test)

The IRS and courts look at whether the income has "ripened" into a fixed right to receive cash. There is no "bright line" date (like a signed contract), but rather a "facts and circumstances" test.

Factors that trigger the trap:

• A Binding Agreement: If you have signed a definitive purchase agreement, it is almost certainly too late.

• Lack of Risk: If there are no more "meaningful contingencies" (e.g., all inspections are done, financing is secured, and the board has approved), the IRS may argue the sale was a "fait accompli."

• The "Housenheid" Warning: A 2023 Tax Court case (Hoensheid v. Commissioner) reinforced that even if a contract isn't signed, if the parties are acting as if the deal is certain (e.g., already distributing bonuses or finishing all legal hurdles), the gift may be invalidated for tax purposes.

How to Avoid the Trap from Springing

To ensure your charitable strategy holds up under IRS scrutiny, follow these  principles:

1. Gift Early: The best time to gift is often after a Letter of Intent (LOI) is signed but before the definitive purchase agreement is drafted.

2. Retain "Real Risk": There must be a legitimate chance that the deal could still fall through at the time of the gift. If the charity is legally "bound" to sell to your buyer the moment they receive the shares, the IRS will likely disqualify the gift.

3. Get a "Qualified Appraisal": For private stock gifts over $10,000, the IRS requires a formal appraisal from a qualified professional. This must be done within 60 days of the gift.

4. Transfer Ownership Completely: The charity must actually own the shares. They should have the right to vote (if applicable) and the right to walk away from the deal if they choose.

Is the Deal Too “Ripe”? Questions to Ask

As a business owner looking to sell, answering the following questions can help you determine if your deal may have gone too far to avoid the trap:

• "Is the Purchase Agreement 'Binding' yet?" If a definitive agreement is signed, the "trap" has likely already sprung.

• "Are there 'Meaningful Contingencies' left?" If the only thing left to do is wire the money, the IRS views the income as "ripened." You need hurdles like due diligence, financing, or regulatory approval to still be active.

• "Does the charity have a 'Legal Obligation' to sell?" To avoid the trap, the charity must be technically free to not sell the shares to your buyer (even if it's obvious they will).

• "Have we triggered 'Constructive Receipt'?" Have any shareholder distributions or "success bonuses" related to the sale already been paid out?

• "Is our appraisal 'Qualified'?" For private stock over $10,000, you need a specific IRS-compliant appraisal. A "back of the napkin" valuation from your CFO will not suffice and is a common reason for deduction denial.

Next Steps

Selling your business is complicated enough without worrying about the IRS "ripeness" test. Building a charitable strategy into your exit requires precise timing to ensure your generosity doesn't turn into an unexpected tax bill.

At Generosity Nexus, we’ve assembled a team of experts to guide you through every step of the process, ensuring your exit is as smooth as it is impactful. Don’t hesitate to schedule an appointment to learn more about how we can help you.