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Tuesday August 14, 2018

Case of the Week

Barbara Banker's LoBank Letter of Agreement

Case:

Barbara Banker started with nothing. She did not own a bank, nor did she have anything to place in the bank. Barbara lived in a midsized town and worked in the local hardware store where 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. In fact, when the town drugstore owner wanted to retire, she bought it under a similar plan. Later, Barbara started buying apartment buildings in town. Since she needed financing, Barbara became good friends with the town bankers.

Two bankers 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 (with the name LoBank). Years later, the bank's services and value have greatly increased. Barbara is a respected businesswoman and now owns a large block of stock in LoBank.

As a strong community supporter, Barbara gives regularly to her favorite local charity. She would like to make a large gift of bank stock to this charity for a new youth center. But as a director she knows that LoBank directors have approved signing a letter of agreement for sale of all LoBank stock to MegaBank from a large city nearby. Barbara met with her CPA to discuss the gift.

Question:

Barbara explained, "My favorite charity would like to name the new youth center after me. I am interested in supporting youth, and this center would be a fine addition to 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 there is a letter of agreement. Can I still make this gift? Are there any problems?"

Solution:

Barbara's CPA explained that it is possible to make a gift of LoBank stock at this time.

After negotiations, the next step in the C corporation sale process is to sign a letter of intent. The letter of intent is negotiated and deemed acceptable by both the buyer and the seller. It normally does not require specific actions by either party. Rather, the letter of intent is a description of the proposed sale arrangement.

In Gerald A. Rauenhorst, et. aux. v. Commissioner; 119 T.C. No. 9; No. 1982-00 (7 Oct. 2002), the court noted, "[T]he letter of intent was not an offer; it was neither a purchase, tender, or exchange offer as the antidilution provision specifies." The Rauenhorst court stated that the letter of intent and the resolution accepting the letter of intent "[did] not demonstrate that the warrant holders were legally bound, or could be compelled, to sell their stock warrants at the time of the assignments."

Therefore, with a typical letter of intent there is a description of the proposed sale transaction, but neither party is legally bound to complete the agreement. Thus, there is no Rev. Rul. 78-197 binding agreement that precludes transfer of the stock to charity or to a charitable trust. Barbara may complete the gift of LoBank stock, bypass the capital gain and deduct the appraised value. This will be a 30% type appreciated gift. If she cannot use the full gift amount under the 30% limit for this year, Barbara may carry forward the remaining gift value for up to five additional years.

Published January 12, 2018
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