If you are
planning to sell a business, the sale could result in a huge capital gain. But
there’s a way to reduce the tax bill, provide for a comfortable retirement and
help out a favorite charity – all in one shot.
Strategy: Donate the business interest to a charitable
remainder unitrust (CRUT). The CRUT can sell the business later, which will
generate cash that can be reinvested elsewhere. However, you cannot prearrange
the sale of the business at the time it is donated to the CRUT.
Example: Ed Caldwell’s business is worth $3 million. He has
zero basis in the company stock, so a sale would result in a $450,000 federal
income tax bill at the current 15% tax rate for long-term capital gains – not
even counting any possible state and local taxes. Instead, Ed donates the
company stock to a CRUT. Typically, the trust promises to pay Ed – or his
spouse or both – a stream of income that can last a term of years or lifetime
(or lifetimes). After the trust’s termination, the remainder goes to the
charity named by Ed.
With a CRUT, the donor receives an annual payment equal to a
percentage or trust assets (5% is the minimum). The higher the percentage, the
more income the donor can expect to receive and the smaller the charitable
deduction. The CRUT must project that the charity will ultimately receive a
remainder value equal to at least 10% of the current value of the business.
Suppose that Ed’s charitable intent is minimal. Depending on
his age and the current level of interest rates, he and his spouse might
specify a 9% trust payout as long as either lives. (We’ll assume the 9% figure
for the rest of this example.) With a 10% projected charitable remainder, Ed
would get a charitable deduction of $300,000 (10% of $3 million). If he can’t
use the entire write-off right away, this $300,000 write-off can be spread over
the current year and the following five years.
The payout: Donating company stock to a CRUT is not a taxable
event. Subsequently, someone interested in buying the company can purchase it
for $3 million. Since a charitable trust owes no tax, it will have $3 million
to invest, perhaps in a portfolio of publicly traded stocks.
Because the trust owes no capital gains tax and has $3
million to invest, Ed starts out with an income payout of $270,000 from the
trust (9% of $3 million). Depending on how the trust invests its money, some of
the income he receives may be passed through as favorably taxed capital gain or
a return of principal.
Each year, Ed’s income will fluctuate, depending on the
trust’s investment performance. If the trust assets balloon to $3.5 million in
year two, his income will rise to $315,000. On the other hand, if the assets
fall to $2.5 million, Ed receives $225,000.
This cycle will continue as long as either spouse is alive.
Depending on how the trust assets are invested, the payout is based on the 9%
figure. Thus, if the trust assets eventually dwindle down to $100,000 the
payout will be just $9,000.
The benefits for CRUT donors are:
- A stream of income for life or a specified term of
years
- Turns capital gain into a current charitable tax
deduction
- Possibility of multiple beneficiaries
- Reinvestment of assets transferred to the trust
- Ability to choose the trustee
- Flexible investment options for the beneficiary.
