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Saturday, April 27, 2024
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Case Studies |
Swenson "Early" Retirement, Part 3
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Case:
Bill and Clara Swenson consider themselves very fortunate. Bill was born in Norway. When he was seven years old, his parents immigrated to America. He attended high school and State College in Northern Minnesota. After he received a business degree, Bill moved back home and started a snowmobile and boating dealership. He and Clara worked very hard and now own two other dealerships. All are proprietorships. They also bought a small hotel and four commercial properties in town.
Bill and Clara are now age 68. As Bill says, "My father worked until age 75, but that's not my plan. I fully intend to take early retirement at age 70."
What plan will work for Bill and Clara? They have a substantial IRA and also have certificates of deposit. Bill would like to sell out and spend the winters in Arizona. He and Clara are also ready to give up management of the hotel and the four commercial properties. They would like good income and want to give a reasonable inheritance to their four children. But as Bill says, "We started with nothing, and we want to give them some help. But they should also have the American advantage of being able to say they are 'self-made' persons."
Bill and Clara support their church, the Norwegian Heritage Center and several local charities that assist youth and those in need. When asked if he would be willing to look at a plan to reach their goals, Bill responded with a hearty, "You betcha!"
Question:
Can Bill and Clara sell the dealerships tax-free? Where should the plan start?
Solution:
Bill and Clara have previously funded a charitable remainder unitrust (CRUT) plan with two commercial properties. They now are talking to two different potential buyers of the snowmobile and boating dealerships. Since they enjoyed the tax-free sale and charitable deduction benefits of the CRUT, Bill suggests that the dealership should be placed in the CRUT and sold.
But there is a large problem. A CRUT is not exempt from tax if it is running a business. So how can Bill and Clara transfer their business to a CRUT that could sell it tax-free? The solution is a lease. Bill and Clara create a three-month lease with two key employees who lease the entire business. The lease pays Bill and Clara a fixed amount each month that is a fair amount based upon last year's profits. Any extra profit above the fixed-lease payments goes to the two employees.
Since fixed-lease payments are permitted under CRUT income rules, once the lease is in place, Bill and Clara can transfer the entire business to the CRUT (still subject to the lease). But there still is a potential problem with this plan. The CRUT owns the business subject to the lease, but the lease payments are made to Bill and Clara.
Even though the lease is held by unrelated persons (the two employees) there could be a violation of the self-dealing rules.
Charitable trusts are subject to the self-dealing rules under Sec. 4947(a)(2). The self-dealing rules are triggered when a disqualified person is involved with the charitable trust in a sale, lease, loan or other transaction.
The self-dealing rules are not avoided by using intermediaries, whether individuals or organizations. But fortunately, there are several exceptions to the self-dealing rules. One exception is that under the incidental exception to self-dealing, one may make payment for some personal services. These personal services must be reasonable and necessary and the compensation may not be excessive. Reg. 53.4941(d)-3(c)(1). Under the general theory of this exception, there is some possible risk, but if the lease is fixed and the time for sale is reasonably rapid, the risk is reasonable.
With Bill and Clara, the trustee quickly sells the businesses to one of the two buyers. Since there is no binding agreement for sale when the CRUT is funded, the CRUT benefit of capital gains bypass is preserved and the self-dealing problems are avoided.
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