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Sunday, May 5, 2024
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Case Studies |
Spicy Options for Restauranteur, Part 4
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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.
As an active philanthropist, David is disappointed that he cannot transfer his ISOs to charity during his lifetime. However, after exercising his ISOs, David wants to know if he can make charitable transfers with The Enchilada Factory stock?
Question:
As an active philanthropist, David is disappointed that he cannot transfer his ISOs to charity during his lifetime. However, after exercising his ISOs, David wants to know if he can make charitable transfers with The Enchilada Factory stock?
Solution:
ISOs are generally not transferable during an 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.
However, once David exercises his ISOs, he no longer owns stock options. He then owns The Enchilada Factory stock. This is an important distinction because the rules regarding transfers of company stock are much more flexible than to the rules regarding transfer of ISOs.
Once the ISOs are exercised and the stock holding period is met, David has a great deal of planning flexibility. Simply put, David now owns long-term capital gain assets. Accordingly, the stock is similar to other types of highly appreciated stock. Thus, David may transfer the stock outright to charity or to a CRT or CGA. The options are endless.
Since this is a gift of appreciated stock, the tax rules applicable to gifts of appreciated long-term capital gain property will apply, e.g. 30% AGI limitation. Because The Enchilada Factory is publicly traded, David will not have to obtain a qualified appraisal for his stock gift. Not surprisingly, David is extremely pleased with these benefits. Charitable giving with the exercised "ISO stock" allows him to achieve his future philanthropic goals in a very tax efficient manner.
Editor's Note: For a discussion on the holding period requirements, see Part 1 of this series. For a discussion of the tax consequences of exercising ISOs, see Part 2 of this series.
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