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Sunday, May 5, 2024
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Case Studies |
S Corporation Gifts - Strategies and Hurdles Every Advisor Should Know, Part 3 - The Oil & Vinegar CRT
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Case:
Tommy Ely, 58, owns and operates eight car dealerships spread throughout the city and surrounding areas. Founded in 1977, Tommy is the sole shareholder of Ely Motorsports, Inc., an S corporation. The eight car dealerships represent mainly high-end, luxury car lines. Specializing in providing unparalleled customer service before, during and after the sale, Ely Motorsports appeals to the affluent and wealthy. Not surprisingly, Ely Motorsports generates over $250 million annually in sales and consistently ranks among the nation's top five best dealerships, a record 12 years in a row.
As a long-time active member of the community, Tommy is frequently invited to charity fundraisers and events. Tommy is also one of the top ten richest people in the city, which probably does not hurt his popularity either. At a recent fundraising function for at-risk youth, Tommy publicly pledged $1 million. Tommy is constantly supporting at-risk youth programs in the local community. In fact, Tommy was an at-risk youth himself. Having run away from an abusive home at age fifteen, Tommy actually lived on the streets for a brief time. Fortunately, Tommy was befriended and taken in by volunteers of the local at-risk youth center at the age of sixteen. Through love, support and counseling, Tommy turned his life around and the rest is "car" history. Consequently, the $1 million pledge announcement and lifetime support of at-risk programs was not a surprise to the people who know Tommy's story.
Question:
Tommy wants to satisfy his $1 million pledge obligation with a gift of approximately 3,000 Ely Motorsports shares (approximate value of $3 million) into a CRUT. The present value of the remainder interest is more than $1 million and, therefore, it would satisfy Tommy's pledge. What are the tax benefits and pitfalls to Tommy if he contributes S corporation stock into a CRUT?
Solution:
Prior to 1998, a Section 501(c)(3) charity could not be an S corporation shareholder. Thus, donors could not contribute S corporation stock to charities without adversely affecting the corporation's tax status. However, commencing January 1, 1998, the Code was amended to permit a Section 501(c)(3) charity to be a shareholder of an S corporation. That is the good news. The not-so-good news is that there was not an amendment to also include charitable remainder trusts. As a result, a CRT is not a permissible S corporation shareholder.
Pursuant to the Code, only certain people and entities are eligible S corporation shareholders. The list includes individuals, estates, Section 501(c)(3) charities, certain retirement plans and certain types of trusts. Unfortunately, a Section 664 CRUT is not one of the permissible trusts.
If Tommy transfers his S corporation stock into a CRUT, then Ely Motorsports will lose its S corporation tax status instantly. In other words, Ely Motorsports' S election would be revoked and Ely Motorsports would immediately begin being taxed as a C corporation on the day of transfer. In most instances, this is not an acceptable result because of the double taxation nature of C corporations.
Based upon the adverse tax consequences, Tommy's advisors recommend against using a CRUT funded with S corporation stock. Simply put, a CRUT and S corporation stock are like oil and vinegar - they don't mix well together. Consequently, Tommy decides to fulfill his $1 million pledge with an outright gift instead.
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