|
Friday, May 3, 2024
 |
Case Studies |
A Charitable Buy-Sell Agreement
|
Case:
Wayne and Nancy Allen started a small parts supply business over 30 years ago. Over the years the business, which is a C corporation, has grown substantially and now the enterprise is worth over several million dollars. Their son, Marcus, is very active in the business and currently owns 20% of the stock. Three years ago Wayne suffered a severe stroke and passed away shortly thereafter, leaving Nancy with ownership of 80% of the company. The company has very strong earnings and has a retained earnings problem. As was explained by their CPA, an annual penalty tax on "accumulated taxable income" can be imposed on certain corporations that accumulate earnings and profits in the form of liquid assets to avoid income tax to the shareholders. In other words, by permitting earnings and profits to accumulate inside the corporation instead of being distributed, as dividends, their corporation could become subject to this onerous tax. This tax is imposed in addition to other taxes, such as the regular corporate tax. Their CPA further stated that because of the substantial accumulation of retained earnings, the corporation is right on the borderline of being subject to this tax.
Marcus and his mother are very concerned about the possible imposition of this tax, but Marcus has an even graver concern. He does not currently have a buy-sell agreement in place with his mother and would not have enough money to buy back all of the stock anyway. Marcus was not worried about this until recently when his mother began to contemplate remarriage. She is engaged to a younger man and has left Marcus concerned about who would end up with control of the business if the new husband were to outlive his mother.
Nancy serves on the foundation board of the children's hospital where she and her husband had served and volunteered for a number of years. The hospital is raising funds to build a new cancer wing and Nancy would like to play a major role in the current campaign. However, the problem is that the bulk of her estate is made up of company stock and is illiquid.
Question:
How can Nancy address her son's concern that when she passes away, control of the company might not go to him? Also, how can Nancy give the children's hospital a substantial gift (she desires to pledge $1,500,000) that will not markedly affect her current cash flow and liquidity?
Solution:
In a recent meeting with her attorney, Nancy raised these two questions and voiced her concerns. The attorney stated that he had recently worked on a case similar to Nancy's and in his opinion, a similar plan would work very well in her situation. The plan would involve the following steps:
1) To address her son's buy-sell concern, Nancy and Marcus will enter into a formal buy-sell agreement. This agreement would provide that when Nancy passes away, Marcus is required to purchase her stock from the estate and her estate will be required to sell the stock.
2) In order to make the gift of $1.5 million, Nancy will donate $150,000 of her company stock to the hospital each year for a period of 10 years. Since these gifts represent only a small portion of her holdings, the gifts will neither change her current lifestyle nor reduce her current income. Furthermore, the gifts will not change the liquidity situation for her estate or her control of the company.
3) As a result of her annual gift of $150,000 of company stock, she will receive income tax savings of about $60,000 each year. Upon her remarriage, Nancy and her new husband will gift a portion of the tax savings to her son and his wife, thus maximizing their annual gift exclusions. Marcus will use the gifts to purchase an insurance policy on Nancy's life which will provide the liquidity to purchase the stock in accordance with the buy-sell agreement. By the end of the 10 year period, the insurance should be paid up and, no additional premiums should thereafter be required.
4) Upon receipt of the stock by the hospital, the company and the hospital discuss the possibility of whether the company desires to purchase the gifted stock. The company cannot be obligated to buy and the hospital cannot be obligated to sell. However, since the company has a surplus of retained earnings and the hospital desires to sell the stock, the decision is made between both parties to sell the stock to the company.
The results of the charitable buy-sell agreement are many: 1) Nancy makes a gift of $1.5 million to the hospital without changing her cash flow, liquidity and lifestyle, 2) The buy-sell agreement is financed at minimal cost and Marcus has confidence that he will own all of the company in the future, and 3) The company has solved the retained earnings problem.
|
|
|
|
