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is that the charitable deduction arises at the time the option is exercised by the charitable donee.⁴⁸

      Thus, the transfer to a charitable organization of property subject to an option by the option writer is similar to the transfer of a note or pledge by the maker (see previous discussions). In the note situation, there is a promise to pay money at a future date; in the pledge situation, there is a promise to pay money or transfer some other property, or to do both, at a future date. In the option situation, there is a promise to sell property at a future date.

These rules were interrelated by the IRS with the private foundation restrictions⁴⁹ in an instance involving a pledge by a corporation of an option on its common stock to a private foundation. The option document permitted the foundation to transfer the option to one or more charitable organizations, but the foundation decided not to exercise the option. The corporation was a disqualified person with respect to the foundation,⁵⁰ and the transaction would have been an act of self-dealing.⁵¹ Thus, the foundation was to sell the option, at its fair market value, to an unrelated charitable organization. The IRS ruled that the corporation will be entitled to a charitable contribution deduction in the year the charitable organization exercises the option and that the amount of the contribution will be the excess of the fair market value of the stock at the time the option is exercised over the exercise price.⁵²

A charitable deduction can also arise when the option expires. In one instance, an S corporation executed a deed, contributing a tract of land to a charitable organization; the corporation retained an option to repurchase the land for a nominal amount. The IRS concluded that there was more than a remote possibility that the option would be exercised. The gift was made in 1993; the option was set to expire in 1995. For 1993, each of the shareholders of the corporation claimed a charitable contribution deduction for their share of the fair market value of the property. The IRS, however, determined that, because of the option, there could not be charitable deductions for 1993, but that the deductions could be taken with respect to 1995.⁵³

§ 4.11 CONTRIBUTIONS OF STOCK OPTIONS

For-profit corporations may pledge stock options to charitable organizations. These transactions can generate tax law issues, particularly if the donee is a disqualified person with respect to the donor, such as by being a substantial contributor.⁵⁴ These issues of law include the timing of the resulting charitable contribution deduction. This aspect of the law is reflected in an IRS private letter ruling.⁵⁵

      In this instance, a for-profit publicly traded corporation established a private foundation as its charitable giving vehicle. This corporation, being a substantial contributor to the foundation, was a disqualified person with respect to it. The corporation proposed to pledge to the foundation stock options for the purchase of shares of common stock of the corporation; the corporation did not receive any consideration for this pledge. The business purpose underlying the pledge was to further the charitable purpose of the foundation and other charitable organizations.

The options will be exercisable at a price specified in a stock option pledge agreement. This private foundation will not exercise the options directly because payment of the purchase price to the corporation would be an act of self-dealing.⁵⁶ Rather, the foundation will either transfer the options to one or more unrelated public charitable organizations or engage in a cashless “net exercise” transaction with the corporation. Pursuant to this net exercise procedure, the holder of options would elect to receive shares of the corporation's stock in an amount equal to the net value of the options being exercised on the date of exercise. This net value of the options is calculated by subtracting the exercise price for the number of the options being exercised from the value of the shares that the holder would have received as the result of a direct exercise. If the holder were to elect the net exercise procedure, the holder would notify the corporation of the number of options being exercised, along with written notice of its election to use the procedure, and the corporation would issue to the holder the number of shares of the corporation's stock computed using a formula specified in the option pledge agreement.

      The foundation may sell the stock options to an unrelated charity for a fair market value price, with the value of the option affected by the terms in the option pledge agreement. Alternatively, the foundation may grant options to an unrelated charity, with the grantee expected to exercise the options prior to their expiration.

The IRS ruled that the pledge of the stock options by the corporation to the foundation did not constitute self-dealing because of the absence of consideration and because of the charitable purposes to be served. The pledges are not extensions of credit.⁵⁷ The net exercise procedure does not entail a sale or exchange, the IRS concluded, so there would not be self-dealing for that reason. The sale of an option by the foundation to an unrelated charity would not be self-dealing inasmuch as the cancellation of the enforceable pledge would be for consideration paid by a nondisqualified person or an entity not controlled by a disqualified person. The exercise of a stock option by an unrelated charity also would not constitute self-dealing.

Stock options are not assets susceptible of use to produce interest, dividends, rents, or royalties. Thus, the proceeds received by the foundation from the sale of stock options to an unrelated charity would be excluded from the computation of the foundation's net investment income for tax purposes.⁵⁸ The IRS ruled that the gain on the sale of stock options would be excluded from the computation of the foundation's unrelated business income.⁵⁹

The IRS ruled that, if the foundation transfers the options to an unrelated charitable organization and that charity engages in a cash exercise of the options, the corporation will be entitled to a federal income tax charitable deduction only on the exercise of the options by the unrelated charity. Moreover, the agency held that this deduction will be for an amount equal to the difference between the exercise price and the fair market value of the corporation's stock transferred on the exercise. The IRS also ruled that, if the foundation engages in a net exercise of the options, the corporation will be entitled to a charitable contribution deduction only at the time of the exercise. This deduction will be for an amount equal to the fair market value of the corporation's stock transferred to the foundation on the exercise. The IRS further ruled that, if the foundation transfers the options to an unrelated charity and that charity engages in a net exercise of the options, the corporation will be entitled to a charitable deduction only at the time of the net exercise. This deduction will be for an amount equal to the fair market value of the corporation's stock transferred to the charitable organization on the net exercise.

§ 4.12 CONTRIBUTIONS OF CREDIT CARD REBATES

A deductible charitable contribution can arise when the user of a credit card causes a percentage of the price of an item purchased with the card at a participating retailer to be transferred, by the company sponsoring the card, to a charitable organization selected by the cardholder.⁶⁰

      A cardholder may claim the deduction for the tax year in which the company made payments to one or more charitable organizations on the cardholder's behalf. The company is not functioning as an agent

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