Many Business Leaders Use Tax Loophole in Donating Stock Gifts

Many corporate executives who have donated company stock to their family foundations have earned bigger tax breaks by backdating their donations to correspond to peaks in the value of their shares or using inside information from their positions to donate their shares before significant price declines, according to a new study.

Those strategies — outlined this month in a report on such donations by David Yermack, a New York University professor of finance — allow executives to claim tens of thousands of dollars in tax breaks for their contributions and shield themselves from paying capital-gains taxes that would have been due had they sold their shares on the open market.

The study, which analyzed 151 stock gifts of $1-million or more made by corporate chief executive officers and chairmen from mid-2003 to the end of 2005, found that, on average, the gifts occurred at peaks in a company’s stock prices.

Often, these donations followed run-ups in the stock prices and or happened just before significant price drops, a phenomenon Mr. Yermack says happened in the case of as many as 20 percent of the donations in his study.

Loophole in Federal Law

In some cases, Mr. Yermack says, those executives are taking advantage of gaps in the law that allow corporate insiders to donate stock at times when they would be prohibited from selling those shares on the open market because the sales would be the result of inside information about their companies’ performance.

“While seeking to subsidize good works in society, they simultaneously follow aggressive tax-evasion strategies,” Mr. Yermack wrote in his report. “Insider-trading laws do not apply to gifts of stock, and donor executives appear to exploit this loophole by donating shares at favorable times in order to increase their personal income-tax benefits. This behavior raises an interesting question of whether CEO’s would donate as much if insider-trading laws were enforced to curb this strategic timing.”

But while some executives appear to be taking advantage of a loophole in the law, others are probably using their influence to manipulate the timing of these transactions to improve their tax benefits, Mr. Yermack says.

Some executives in the study appear to have backdated their donations — meaning they donated the stock after its share price had dropped but arranged for their foundations to make it appear as though it had been donated when the stock was trading at a higher price.

“Such backdating would require coordination between the foundation’s trustees (generally the CEO and his family) and the company’s stock-transfer department (which reports, at least indirectly, to the CEO),” he writes. “This sort of collusion is not difficult to imagine.”

In such cases, these executives would have been violating federal tax laws that prevent the backdating of stock sales.

In the largest cases in the study, Mr. Yermack says, executives saved $150,000 or more in taxes. The study did not name any of the executives, foundations, or companies it examined.

Dean Zerbe, a tax lawyer in Washington and a former top aide to Sen. Charles E. Grassley, Republican of Iowa, says the study’s findings could prompt the Senate Finance Committee and the Internal Revenue Service to focus their attention on stock donations to private foundations.

“The committee has had a lot of interest in the backdating of stock options in the employment area,” Mr. Zerbe says. “I would imagine that the committee would also have a strong interest in this area as well.”

Tightening the Rules

Based on his findings, Mr. Yermack says he believes the government should consider tightening the rules governing donations of stock to charity.

“The results of this paper indicate that two groups may be systematically harmed by opportunistically timed stock gifts: taxpayers and charities,” he says. “And the government has a longstanding interest in protecting each of these large constituencies.”

And that interest could ultimately extend beyond family foundations. Mr. Yermack says that, while public-disclosure laws made it easy for him to focus on the activities of family foundations, it is possible that other nonprofit groups have been accepting similar gifts and coordinating with donors to misreport the timing of a donation to maximize the potential tax benefits.

“You are much more likely to find it at family foundations than in other organizations, but I wouldn’t want to rule it out,” he says.