Case of the Week

Case:

Barbara Banker started with nothing. She lived in a midsized town and worked in the local hardware store. The store owner noticed her industrious efforts and strong work ethic. When he decided to retire, he suggested that Barbara could take over the hardware store and pay him over a term of 10 years from store profits. Barbara did exactly that. When the town drugstore owner wanted to retire, Barbara bought the store under a similar plan. Later, Barbara started buying apartment buildings in town. Since she needed financing for these purchases, Barbara became good friends with the town bankers.

Two bankers eventually approached Barbara about starting a new local bank. She agreed to be one of the initial directors and they all invested in the local bank, which they named LoBank. Over the years, the bank's services and value greatly increased. Barbara is a respected executive and now owns a large, valuable block of LoBank stock.

As a strong supporter of her local community, Barbara gives regularly to her favorite local charity. She would like to make a large gift of bank stock to the charity to be used to build a new youth center. But as a director she knows that LoBank's directors have approved signing a letter of agreement for the sale of all stock to MegaBank, a bank located in a nearby large city. Barbara decides to meet with her counsel to discuss the gift.

Question:

Barbara explained, "My favorite charity has a naming opportunity for the new youth center and has asked me if I would consider making the lead gift. I am interested in supporting youth, and this center would be a fine addition for our town. The LoBank stock has gone way up in value, but I have heard that there may be problems with this gift now that the board voted to accept the offer from Megabank and 75% of the shareholders have also voted in favor of the sale. Can I still make this gift? Are there any problems?"

Solution:

Barbara's counsel explained that if she makes a gift of LoBank stock, there will not be any bypass of the capital gain. The fourth step in the bank's sale process is a vote by the shareholders to accept the buyer's offer. The LoBank sale status is now very similar to the prearranged sale in Ferguson v. Commissioner, 108 T.C. 14 (28 Apr 1997).

In Ferguson, the selling company's (AHC) stock was widely held, and the 50% threshold was not crossed until the shareholders voted. While the gift was planned prior to the 50% vote in favor of the sale by the shareholders, the actual gift was not completed until after 50% of the shareholders had voted to accept the sale offer. On August 31, 1988, 52% of the AHC shares had been tendered in acceptance of the sale offer and the gift was made on September 8, 1988. The Tax Court held that a binding obligation had been created prior to the gift and there would not be a bypass of gain on the transfer of the stock. The Tax Court noted, "At that time, despite the various contingencies to be discussed infra, we believe the reality and substance of the merger agreement and the tender offer indicate that the stock of AHC was converted from an interest in a viable corporation to a fixed right to receive cash."

Because over 50% of the LoBank shareholders voted in favor of the sale, the obligation is now effectively binding and the sale is subject to the binding agreement standard of Rev. Rul. 78-197. In Estate of Scott M. Hoensheid et al. v. Commissioner; No. 18606-19; T.C. Memo. 2023-34, the Tax Court determined the taxpayer transferred stock to a donor advised fund after the transaction was virtually certain and the gain had ripened. As such, Barbara will not be able to bypass the gain on the LoBank stock if she makes a gift of the stock at this time.