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Sunday, May 5, 2024
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Case Studies |
Economics vs. Charitable Intent... A High Payout Trust is the Solution
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Case:
Sam Crawford, age 65, started a parts supply business over thirty years ago and with hard work and entrepreneurial expertise has built the company to a value of $5,000,000. Sam never married, has one brother and sister and would like to retire this year. The business is structured as a C corporation and five key employees have expressed an interest in purchasing 100% of the stock of the company. Both Sam and the employees feel that the $5 million value is a very fair price and would like to begin serious deliberations to purchase the company within the next 12 to 18 months. However, at this point, there has been no formal offer by the employees - only discussions "around the lunch table."
Sam has run the possible sale of the business by his CPA who thought it was an excellent price for the business. His CPA did explain to him that he would be subject to capital gains taxes on the $5 million sale. Since he started the business "on a shoe string" Sam has no cost basis in his stock and, therefore, would be subject to significant capital gains taxes. Sam was very disturbed by this tax as he didn't want to see so much of his labor over the years go to the government; but he thought, "Oh well, I might as well bite the bullet."
Sam is known by his peers, his employees and his family as a penny pincher. He has rarely made any gifts to charity, has saved practically every dime he made and has always made it a point to live a very frugal existence. However, he has begun to do some volunteer work with the local rescue mission assisting those in the job training program. He has received such satisfaction in doing this that upon his retirement, he plans to spend at least twenty hours a week volunteering in this capacity. While at the rescue mission he has become good friends with the Director of Major Gifts, Ken Davis. While he and Ken were having lunch one day, Sam stated that he was contemplating selling his company, but was very concerned about the capital gains bite. Ken mentioned the charitable remainder trust to him stating that capital gains taxes could be bypassed, he would receive lifetime income, a nice tax deduction and the trust would eventually pass to charity. Sam, however, was quite unwilling to 'give up' control over the $5 million and see it ultimately pass to charity. In other words, his charitable intent was extremely low.
Question:
In other discussions with Sam, Ken asked him if he would be open to a charitable gift to the rescue mission assuming the "numbers worked." Is there a charitable giving method which could be presented to Sam which would work economically for him?
Solution:
Ken suggested the possibility of using Sam's company stock to create a very short term charitable remainder unitrust with a payout rate of 50%. For example, assume the trust lasted for a period of only three years. Based upon a trust return of 10%, Sam's projected income from the trust over the three-year period would be $4.9 million. Most, if not all, of this income would be taxed at capital gain rates. In addition, Sam would receive an income tax deduction of $689,665 which would result in income tax savings of over $250,000. Therefore, combining the income of $4.9 million with the $250,000 plus in tax savings would result in Sam receiving in excess of the original funding amount of $5 million.
Ken didn't stop there. Based upon the projected 10% trust return, the rescue mission would receive over $1 million from the charitable trust at the end of the three year period. Sam was elated. "You mean," he said, "that I could receive over $5 million in benefits from this trust and still make a gift of over $1 million to the rescue mission!?!" Ken stated that yes, indeed, this was the case. However, Ken did add the disclaimer that the income projections to Sam and the ultimate gift to the rescue mission are based upon an assumed trust return of 10%. The income projections and the gift to the mission could increase or decrease based upon the trust investment returns.
Sam never anticipated that he would one day be a philanthropist of such magnitude. By selling his company through the unitrust, he would be able to make a substantial financial impact on the rescue mission and still feel that none of his personal resources have been compromised.
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