- 18-Apr-2025
- Education Law
Gifting shares before an Initial Public Offering (IPO) can raise complex tax considerations for both the giver (donor) and the recipient (donee). The primary concerns are whether the gift is subject to gift tax, how to determine the value of the shares, and whether any capital gains tax will apply once the shares are eventually sold. Understanding the tax implications of gifting shares before an IPO is crucial for effective estate and tax planning.
When shares are gifted before an IPO, they are subject to gift tax rules. The IRS allows individuals to gift up to a certain amount each year without incurring gift tax. For 2025, the annual exclusion for gifts is $17,000 per recipient. If the value of the shares being gifted exceeds this annual exclusion amount, the donor may be required to file a gift tax return (Form 709).
Example: If shares worth $25,000 are gifted to a recipient, the donor must file a gift tax return. However, the donor will only owe gift tax if their lifetime exemption (which is currently set at $12.92 million in 2025) has been exhausted.
One of the most challenging aspects of gifting shares before an IPO is determining their fair market value (FMV). Since the shares are not yet publicly traded, the value must be based on an estimated valuation. Often, this involves:
When the shares are eventually sold after the IPO, the recipient will likely owe capital gains tax on the difference between the sale price and their cost basis. The cost basis is typically the value of the shares at the time they were gifted to the recipient.
When shares are gifted, the recipient generally inherits the donor's cost basis (the original purchase price of the shares). If the donor purchased shares at $10 per share, and the shares are valued at $25 per share at the time of gifting, the recipient's cost basis will remain at $10 per share. If the shares increase in value after the IPO and are sold at $50 per share, the recipient would owe capital gains tax on the $40 per share gain.
The holding period of the donor is also transferred to the recipient. This means if the donor held the shares for more than a year, the recipient may benefit from long-term capital gains tax rates on any future sale of the shares, provided the shares are sold more than a year after the original purchase date.
Before the IPO, the shares are privately held, so the market value is speculative. If the company’s IPO price is lower than the pre-IPO valuation, there could be a discrepancy between the expected market value and the actual sale price of the shares. This could affect both the donor's gift tax obligations and the recipient's future capital gains tax liability.
Example: If the shares are gifted before the IPO at a valuation of $100 per share but the shares are ultimately offered in the IPO at $80 per share, the recipient may be at a disadvantage when selling the shares post-IPO due to a lower market price.
Often, shares gifted before an IPO are subject to lock-up periods, meaning the recipient cannot sell the shares immediately after the IPO. This could impact the recipient’s ability to realize any gains from the sale of the shares and may affect the planning for any potential tax liabilities.
Gifting shares before an IPO can also have long-term estate planning benefits. By gifting the shares while they are still private, the donor may reduce the value of their taxable estate, potentially reducing any estate tax liabilities upon their death. However, the donor must carefully consider the timing of the gift, its impact on their overall estate planning, and whether it makes sense to gift shares that could appreciate significantly in value post-IPO.
Suppose a person gifts 1,000 shares of a privately held tech company to their child before an IPO. The shares are valued at $10 per share, so the total value of the gift is $10,000. Since the value is below the annual gift exclusion of $17,000, no gift tax is due.
After the IPO, the stock price rises to $50 per share. The child’s cost basis is still $10 per share, and if they sell the shares at $50, they will pay capital gains tax on the $40 per share gain, which totals $40,000 in capital gains.
Shares gifted before an IPO can have several tax implications, including gift tax and capital gains tax. The value of the gift must be properly assessed, and the donor may need to file a gift tax return if the value exceeds the annual exclusion amount. The recipient will inherit the donor’s cost basis, which affects the capital gains tax liability when the shares are eventually sold. Estate planning considerations and the timing of the gift are crucial in ensuring that the transfer of shares is tax-efficient. It is advisable to work with a financial or tax advisor to navigate these complexities, especially when dealing with pre-IPO shares.
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