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Sunday, April 28, 2024
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Case Studies |
Greenco Unitrust Bailout
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Case:
Bill and Clara Green consider themselves very fortunate. Bill was born in Estonia. When he was an infant his parents immigrated to America. He attended high school and State College on the East Coast. After he received an engineering degree, Bill worked for two different companies on the East Coast. He met Clara, married and they have two children, Susan and Harry.
Bill worked for companies that produced different types of industrial control systems. One day, he started working on a control system that would measure various kinds of smokestack emissions. Since the Environmental Protection Agency was now starting to regulate smokestack emissions, Bill thought it would be a great opportunity.
Bill quit his job, took their life savings and started in his garage. He soon hired another engineer and a secretary and set up a C corporation named Greenco, Inc., to produce instruments to measure smokestack emissions. Over the years, Greenco has flourished and grown and now has 30 employees, with customers throughout the nation.
When asked whether Greenco is a good business, Bill responds, "It's a great business. The power companies buy our probes to measure the emissions in their smokestacks. Then the EPA changes the rules! So our customers need to buy updated probes."
Bill is now 70 and Clara is 68. They are planning to transfer the business to Susan, who is now company president, and Harry, who is vice-president of product development. Bill and Clara own all of the Greenco stock.
Question:
How can Bill and Clara make an effective transfer of Greenco to Susan and Harry? Can they benefit from income tax savings and receive additional low-tax income at the same time?
Solution:
Bill and Clara could do a charitable unitrust bailout plan. But Bill and Clara want to retain control for several years, while transferring the majority of Greenco to the children. So Bill and Clara do a "soft" recapitalization. They convert the C corporation stock into 100 shares of voting stock and 10,000 shares of non-voting stock. The transfers to children and charity will be with the non-voting stock. As Bill notes, "I have run this business for 30 years and I plan to stay in control for a while longer."
Since Greenco is valued at approximately $4 million, Bill and Clara created a family limited partnership (FLP) and transferred $2.5 million of nonvoting stock to the FLP. Using their gift exemption available to each person and their per-donor per-donee annual exclusions, plus a 25% discount for lack of marketability on the FLP interests, they transferred the FLP to Susan and Harry. Bill and Clara's CPA obtained an appraisal from a qualified independent appraiser to value the gift and reported the gift on Form 709, the Federal Gift Tax Return. With the combination of the FLP discount, the annual exclusions and the lifetime exemption of each person, there was no gift tax payable.
The next part of the plan was to create a charitable remainder unitrust. Bill and Clara created a 5% net-income-plus-makeup unitrust. They planned to invest unitrust assets for growth. If they desire payouts from the unitrust, they can sell growth equities and make distribution of long-term capital gain. With both dividends and long-term capital gain taxable at 15%, Bill and Clara are very pleased with the unitrust.
Each year for three years, Bill and Clara transfer approximately $500,000 of nonvoting stock to the unitrust. Using the Sec. 4941(d)(2)(F) exception to the self-dealing rules for corporate redemptions of stock, the company then purchases the stock from the unitrust. Over a period of three years, Bill and Clara have transferred a total of $1.5 million to the unitrust and the company has redeemed that stock. Bill and Clara now own only the voting stock. Susan and Harry have received part of the stock through the FLP and effectively own all of the nonvoting stock, since the balance of the nonvoting stock is held by the corporation.
Each year that Bill and Clara made a gift to the unitrust, they received an income tax deduction of approximately $150,000 and saved another $100,000 on the capital gain bypass.
Bill and Clara are delighted that the value of Greenco is now effectively transferred to Susan and Harry. In addition, they have benefited from nearly $400,000 in tax savings and have substantial income from the $1.5 million unitrust.
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