The first is a bedrock ruling from 1978, Revenue Ruling (Rev. Rul.) 78-197. This ruling deals with the situation in which an individual gives closely held stock to a charity, and the donor’s corporation subsequently redeems (buys back) the stock.

In a terse ruling, the IRS said that the buy-back won’t be considered as a redemption of stock from the donor, which would stick the donor with dividend income, so long as when the gift is made the charity isn’t obligated and can’t be compelled to sell the stock back to the donor’s corporation.

This ruling represents a white flag on the IRS’s part, given that the IRS had lost a string of 1970s court cases involving this fact pattern. In those cases, it was apparent the donor’s corporation was going to offer to redeem the donated stock from the charity. It was also clear the charity would accept the offer. The key thing is that the charity was in fact free to accept or reject the corporation’s offer to redeem.

In essence, this ruling says the IRS won’t attempt to connect the dots if the charity itself is free to choose whether to connect the dots.

Rev. Rul. 78-197 has the force of law and may be relied upon by all taxpayers. It has spawned a number of private rulings (PLRs), which can’t be relied upon by taxpayers generally, but which make plain the IRS’s position on connecting the dots.

One PLR from the 1980s, for example, shows how willing the IRS has been to expand the application of Rev. Rul. 78-197. In this PLR, the donor planned to give closely held stock to a charity. All the players anticipated, but merely anticipated, that the charity would sell the donated stock to donor’s family member for fair market value. The IRS said, no problem, given that the charity would be free to sell or not sell.

We’ll pick up this buyer-in-the-wings thread next time. Click here to read Part 2.

By Jon Tidd, Esq