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Monday, May 6, 2024
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Case Studies |
Spicy Options for Restauranteur, Part 3
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Case:
Roger Garcia is CEO of The Enchilada Factory, a chain of upscale restaurants that serves Mexican food geared toward health conscious patrons. Roger opened his first restaurant 30 years ago. With initial table space for a mere 12 people, Roger never could have imagined that this company would grow to over 150 locations with revenue of $800 million per year. Not surprisingly, magazines and trade journals frequently request interviews with Roger and write about his amazing journey to the top.
However, it has not always been a smooth ride. The restaurant business is very competitive and there have been many difficult times over the years. For instance, about seven years ago, the company was on the verge of bankruptcy. Costs were soaring and customer service was abysmal. In need of new direction and new blood, Roger hired David Guerrero as President of the company. Not only did David have an amazing reputation for turning companies around, he had a restaurant business background. As expected, David pumped new life into The Enchilada Factory. He got costs under control, improved customer service and revamped the menu. In just two years, the company turned around and has never looked back.
This wonderful turnaround didn't come cheap, however. In order to acquire David, Roger gave him a substantial six figure salary and a plethora of incentive stock options (ISOs) - 10,000 ISOs to be exact. Given the current profitability and growth of the company, the stock price has skyrocketed in the past seven years. Accordingly, David's ISOs are worth a fortune.
Although very astute in turning companies around, David has less expertise in the field of tax law. Accordingly, he has some questions regarding his ISOs. In this case study series, we will address David's ISO questions and offer some planning options as well.
Next, David wants to know what are his charitable options. Specifically, he wants to know if he can transfer his ISOs to charity?
Question:
Next, David wants to know what are his charitable options. Specifically, he wants to know if he can transfer his ISOs to charity?
Solution:
There are many restrictions regarding who can exercise ISOs. Specifically, David is the only person who can exercise the ISOs during his lifetime. Furthermore, ISOs are generally not transferable during the employee's life. See Sec. 422(b)(5). Therefore, David may not make an inter vivos transfer of his ISOs to charity or to a planned gift, e.g. CRT, CGA or CLT.
This tax code limitation effectively removes any gift possibilities with ISOs. Therefore, the answer to David's question is, "No" - he may not transfer his ISOs to charity during life.
As for noncharitable transfers, spouses, for instance, may not exercise an employee's ISO. Other ISO restrictions include: 1) they may not be assigned pursuant to a divorce settlement, 2) they may not be sold or used as collateral, and 3) they may not be contributed to IRAs and other retirement plans.
As an active philanthropist, David is disappointed with the ISO transfer limitations. However, after exercising his ISOs and obtaining The Enchilada Factory stock, he wonders if he can make charitable gifts with the stock. See Part 4 for the answer to this question.
Editor's Note: For a discussion of the tax consequences of exercising ISOs, see Part 2 of this series.
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