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Sunday, May 5, 2024
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Case Studies |
S Corporation Lease Unitrust
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Case:
Bill Lee is age 64 and owns three car dealerships spread throughout the city. Founded in 1977, Bill and his spouse Amy are sole shareholders of Lee Motorsports, Inc. (LMI), an S corporation. The car dealerships represent mainly high-end, luxury car lines. Specializing in providing unparalleled customer service before, during and after the sale, Lee Motorsports has flourished and grown. It produces over $30 million annually in sales and consistently ranks among the best dealerships.
As long-time active members of the community, Bill and Amy are often seen at charity fundraisers and events. They both started with nothing and believe that now is the time to give something back. Bill is especially oriented toward supporting at-risk youth programs in the local community. In fact, Bill was an at-risk youth himself. Having run away from an abusive home at age fifteen, he actually lived on the streets for a brief time. Fortunately, he was befriended and taken in by volunteers of the local at-risk youth center at the age of sixteen. Through love, support and counseling, Bill turned his life around and the rest is "car" history.
Since Lee Motorsports, Inc. is such a desirable business and there are no comparable locations for new dealerships in the city, Bill knows that he can ask for favorable terms when he sells the business. In fact, he and Amy are ready to retire and move on with life focused on family and their favorite charities.
Question:
How should Bill and Amy structure the sale? Could they sell as an S corporation? Would there be unrelated business income (UBI) or self-dealing problems?
Solution:
Bill has been contacted by a very large company that is willing to make a large offer for his unique business location, clientele and operation. The offer is for the purchase of the assets of the S corporation. Bill would like to sell tax free through a charitable remainder unitrust and the S corporation stock cannot be transferred to a unitrust. So he asked his CPA if LMI's assets could be transferred to a unitrust.
His CPA pointed out three problems with such a plan. First, the unitrust could not be based on Bill and Amy's lives, but would need to be a 20 year term unitrust with income payable to the trust and then flowing through to Bill and Amy. Second, the company's assets are inventory. Placing the business assets in the unitrust and then running the business would produce unrelated business taxable income. Third, using the business assets in a unitrust could violate the self-dealing rules.
The CPA, however, presented a potential solution. If the assets of the business were leased to an employee on a fixed payment lease, there would be no UBI. Provided that the employee operated the business on a short-term lease, there should also not be a problem with self-dealing. Therefore, Bill had LMI create two leases. The first was for the building and the second was for the balance of the Lee Motorsports assets. After the business was leased to the trusted employee, who was not related to Bill or Amy, they transferred the building to a unitrust. The unitrust now receive the payments from the trusted employee under the lease. Bill and his CPA valued the building at about 50% of the total value.
Bill then negotiated a sale of the assets of LMI to the new buyer. The unitrust sold the building and LMI sold the balance of the assets, all for cash. The 20 year unitrust bypassed gain and created a large income tax deduction. Since the sale of the assets owned by LMI created gain and increased Bill and Amy's basis in the LMI stock, the deduction flowed through to their personal return.
As a result, taxes were reduced by 2/3 on the sale. Bill and Amy will receive income from LMI for the next 20 years and that income will be greater because there was minimal loss due to taxation on the sale. After 20 years, the remaining cash will be paid to Bill and Amy and the unitrust principal will benefit their favorite charity.
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