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Wednesday, May 8, 2024
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Case Studies |
Financing for a Song
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Case:
John Elton, age 72, is a very popular musician and songwriter. He recently wrote a song for an internationally known celebrity who was tragically killed in an auto accident, so John decided to give away all the proceeds of the song to charity. However, he still has the original manuscript for the song, which, if auctioned, would probably sell for about $5,000,000.
If John sold the manuscript, he would be required to report the sales price as ordinary income and, therefore, would lose approximately 40% of the amount to taxes. As a philanthropist, he would much rather see the proceeds from the sale go to charity instead of the government, but he would like an income stream on the funds for the rest of his life. Ideally, he would like to receive $250,000 per year.
John's alma mater, a notable College of Music on the East coast is in the process of constructing a fine arts center. The College has reviewed a number of options for financing the building but has become frustrated with the unanticipated costs of carrying mortgage debt on the center due to rising interest rates. John has become aware of the College's need for funds and has considered donating the manuscript, but is unwilling to surrender the opportunity to receive lifetime income from this particular asset.
Question:
John recently discussed this problem with the Collge's Planned Giving Director, Susan Mills. He wondered if there was a way to donate the manuscript to the College, use the proceeds to help the College build the fine arts center and receive lifetime income. John further stated that he was not necessarily interested in any tax benefits, but that the income stream and the gift to the College were his primary concerns.
Solution:
Susan had an excellent idea that would meet John's objectives of lifetime income and assisting the College with its funding needs. Her plan involved a charitable remainder annuity trust funded with the manuscript. Because of the nature of the asset, John would not receive a charitable income tax deduction for funding the trust. However, the manuscript would be sold (auctioned) inside the charitable trust and, therefore, no taxes would be paid on the sale. Assuming that the manuscript would be sold for $5,000,000 and a payout rate of 5% chosen, John would receive the $250,000 per year he desired. These payments would continue for the balance of his life. At his passing, the College would receive the trust assets, since it would be the designated charitable remainderman.
The key that makes this arrangement work for the College is this. The trustee of the charitable trust would lend the entire $5,000,000 to the College in consideration of the trust's receipt of a mortgage indenture. This indenture is the collateral for the borrowed funds. The note would be written for a period of 40 years with no amortization, since John's life expectancy is substantially less than 40 years. The interest rate on the note would be only 5%, which is the required trust payout to John. At John's death, the trust would terminate and the note would become the property of the College and thus would be extinguished. Furthermore, accounting procedures permit footnoting these facts on the College's financial statements so that the "debt" would not affect its creditworthiness.
The College is very pleased with this arrangement. It would be able to borrow $5,000,000 at a very low interest rate, pay no loan costs and never have to repay the principal of the loan. John was invited to the groundbreaking of the fine arts center as the guest of honor. When the building was completed the following year, he was invited to the dedication ceremony, one of the highlights of which was the singing of his famous song by the College choir.
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