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Saturday, May 4, 2024
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Case Studies |
Spicy Options for Restauranteur, Part 5
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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.
Question:
As an active philanthropist, David is disappointed that he cannot transfer his ISOs to charity during his lifetime. However, David wants to know if he can bequeath his ISOs to charity in the event of his untimely death. If possible, how can he implement the bequest? What are the advantages of bequeathing the ISOs to charity?
Solution:
Thankfully, the tax code is more flexible when dealing with transfers of ISOs at death than transfers of ISOs during life. Accordingly, ISOs are an excellent asset to bequeath to charity.
For bequests of ISOs, it is vital that David designates a qualified charity as the beneficiary. Once David passes away, the transfer of the options is completed in accordance with the beneficiary designation. In the event there is no such designation, the options will usually transfer to David's estate, and David's executor will exercise the options. Unfortunately, this may result in income tax consequences to the estate, i.e., IRD.
The beneficiary designation possibilities and limitations are generally governed by the plan of the company that issued the options. The company plan usually sets forth any transfer restrictions and the procedure for naming a beneficiary. The best course of action is for David to contact The Enchilada Factory administrator for a copy of the plan and to follow its procedures meticulously.
If the ISOs are transferred to charity, David's estate will receive a charitable estate tax deduction equal to the value of the options. See Sec. 2055. Moreover, when the charity exercises or disposes of the option, it should not be subject to unrelated business taxable income. See Sec. 512. As a result, the maximum value of the options is transferred to charity without any reduction for income or estate taxes.
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