CGNA: Chapter 4 - Pass-Through Entities, Quick Take-aways

CGNA: Chapter 4 - Pass-Through Entities, Quick Take-aways

Article posted in General on 21 February 2018| comments
audience: National Publication, Bryan K. Clontz, CFP®, CLU, ChFC, CAP, AEP | last updated: 23 February 2018


Next up: Gifts of LLC, LP and other pass through entities.

This article is an excerpt from Charitable Gifts of Noncash Assets, a comprehensive guide to illiquid giving by Bryan Clontz, ed. Ryan Raffin. Published by the American College of Financial Services for the Chartered Advisor in Philanthropy Program (CAP), with generous funding from Leon L. Levy. For a free digital copy, click here, and to order a bound copy from Amazon, click here.

Below are quick take-aways on gifts of pass-through entities. Pass-through entity topics are based on Dennis Walsh’s “Navigating the Charitable Transfer of a Partnership Interest: A Primer,” and Jane Wilton and Nicole Spooner’s “Considerations in Making Charitable Gifts of Interests in Pass-Through Entities.For quick take-aways on gifts of pass-through entities, see Pass-Through Entities Quick Take-Aways. For a review based on the articles, see Pass-Through Entities Intermediate. For an in-depth examination adapted and excerpted from the articles, see Pass-Through Entities Advanced. For further details, see Pass-Through Entities Additional Resources.

Interests in pass-through entities can make for appealing donations. They can be both strong income producing assets for charities, and a tax bargain for donors. These entities are often structured as either partnerships or limited liability companies.

Below is an overview of the advantages, disadvantages, considerations, and essential questions when considering accepting gifts of pass-through interests. Also highlighted are unique aspects of both partnerships and LLCs.

LLC Features to Note:

• Limited exposure to potential liability to third parties in most cases

• LLC operating agreements are more likely to require capital contributions from members

• In some cases, LLCs may elect to be taxed as a corporation

Partnership Features to Note:

• Interests often come with a share of the partnership’s liabilities

• Partnerships may not have a formal partnership agreement

• State partnership law is uniform, unlike LLCs

Advantages of donations of pass-through interests include:

  • The IRS does not tax income at the entity level (pass-through treatment), particularly appealing for charities who receive interests in passive investment entities and are afforded the UBTI exception.
  • Pass-through donations can be structured in a number of ways, depending on the donor’s goals, the form of the entity, and the charity’s desired use.
  • Partnership and LLC interests can be used to fund most every kind of planned gift assuming no debt or other active business income which may generate UBTI and a clear and quick exit strategy.

Disadvantages of donating pass-through interests include:

• Calculation of different elements of the interest can be quite complex (including basis, hot assets, passive losses, and more), meaning valuation is often complicated as well. This impacts the charitable transfer, reporting requirements, and the nonprofit’s eventual sale of the interest.

• The partnership or operating agreement can restrict transferability of the interest, which can also limit marketability of the interest when the charity decides to liquidate.

• Similarly, pass-through interests often have a limited market on sale— typically only the original donor, the entity itself, and other partners or members.

• Pass-through entities can generate unrelated business taxable income, either by virtue of its normal, active business income-generating activities or through debt-financed income.

• A gift of a pass-through entity with debt will trigger bargain sale rules.

• Gifts of unique pass-through entities or property, like carried interests, can be extremely complex and are sometimes subjected to legislative or tax changes.

• Some of these interests can include capital calls or other liability exposures (i.e., general partnership interests).

Discovery Questions

Donor Questions
  1. What is the donor trying to accomplish with the gift?
  2. What is the value of the pass-through entity and how was that determined (e.g., appraisal, recent transactions)?
  3. Is there any debt?
  4. Legally, who or what owns the interests?
Advisor Questions
  1. What is the current tax basis (and is the partnership basis negative)?
  2. Does the operating or partnership agreement allow charitable transfers, and if so, what is the process?
  3. What is the likely exit plan for the charity (e.g., will sale be for cash, note, stock or some combination)?
  4. Does the advisor have an estimate of what a qualified appraisal will cost (this expense can vary greatly and can be an impediment to smaller donations)?
  5. If an asset donation is being explored, will all owners/partners agree on the size of the gift and the charity?
Charity Questions
  1. Is the effort worth the expected benefits (i.e., is the juice worth the squeeze)?
  2. If the interest is in a partnership, is it a limited partnership interest? Otherwise charity is at risk for the partnership’s liabilities.
  3. Has the screening and due diligence process identified any potential problems and can the risks be mitigated (primarily this will be capital calls which can be found in the partnership or operating agreement)?
  4. Is there the necessary expertise to accept gifts of pass-through entities in a timely way?
  5. Should indirect gift acceptance be considered, like using external third party foundations or supporting organizations to receive the asset?
  6. Is there a clear liquidation plan to maximize the sales proceeds as soon as possible?

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