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Sunday, May 5, 2024
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Case Studies |
George's "Green" Sub S Unitrust
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Case:
George Green was a man of humble beginnings. He was born in Bulgaria and lived with his parents on their farm. But George was a diligent student and was determined to become a successful business owner. After high school he obtained permission to come to America to go to college. George applied to several colleges and was accepted as a work-study student at a state college. He lived in the dorm and worked nights in the cafeteria. On weekends, he moonlighted as a waiter at a five-star restaurant.
George was both resourceful and determined to succeed. He enrolled in chemical engineering and studied every spare moment. His industry was quickly recognized by faculty. After graduating with honors, he became a graduate assistant and earned a master's degree in engineering.
George always loved nature. He accepted a position as a product development engineer with a company that built emissions control equipment for automobiles. Soon, George met Helen Wilson and they married.
But he was too energetic to stay in one place. After saving $5,000, he convinced Helen that it was time for him to go out on his own. George started a company that offered environmental consulting. As soon as he could the necessary funds, he started to produce components for emissions control equipment. After a terrific struggle, the business took off and George began to manufacture probes for company smokestacks. When asked if that was a good business, George responded, "It is a great business. Companies buy my probes to measure their smokestack emissions, and the government changes the rules! Then, they all have to buy upgraded probes!"
Later, George incorporated the probe manufacturer as Green Probe (GP). Based upon the advice of his CPA Clara White, he elected Subchapter S status for GP. George has been active in his local charities and accepted a position as Chair of the Board for a local environmental charity. Recently, George received an offer from large company MegaCorp to purchase GP. Since MegaCorp wants to be able to take depreciation on the assets of GP and it wants to minimize liability risks, the offer is for the purchase of all GP assets.
Question:
George would like to accept the offer, but avoid all tax. He contacted his CPA Susan Green and asked, “Is there a way to sell with no tax?”
Solution:
Clara thought for a moment and responded, “George, you have not yet accepted the offer. Therefore, under Rev. Rul. 78-197, you can still create a charitable plan. Since you and Helen would like to retain income, the best solution is a charitable remainder trust. But the CRT cannot hold your Subchapter S stock. We will need to transfer part of the operating assets to a term of twenty years unitrust and then sell to Megacorp.”
Clara continued, “Here is the plan. We will create a short term lease with fixed payments and lease GP to Harold your financial planner. This will eliminate the possible unrelated taxable income to the unitrust from GP. Then we can transfer 55% of GP assets to the unitrust, subject to the lease to Harold. We could transfer more assets and sell tax free, but under Reg. 1. 337(d)-4 we are limited to less than substantially all assets in the unitrust. Practically speaking, we could put about 65% maximum into the trust and be within my comfort level. But let’s use 55% to the unitrust. After the lease is established and the unitrust is funded, Harold can negotiate and sell GP to MegaCorp in an asset sale.”
George was very interested and asked, “But will there be tax on the sale of the 45%?”
Clara responded, “Yes, since you have a low basis, there will be tax upon sale of the 45%. This gain will flow through to you and Helen under the Sub S rules. However, the good news is that the sale of the 55% is tax free. In addition, since the 55% are capital assets, there will be an income tax deduction that flows through to you and Helen based upon the twenty year term of the unitrust. It looks like the unitrust value will be about $2 million, and the charitable deduction will be $550,000.
We are still waiting for Congress to pass the tax extenders this year, retroactive to Jan. 1. If the extenders pass, you will be able to flow through the full charitable deduction. Because the basis on that charitable deduction is only $100,000 and you and Helen have a basis in your Sub S stock of $100,000, the full $550,000 deduction will flow through to you if the tax extenders are passed by the end of this year. It should save enough in taxes to offset the tax on the other $1.8 million on the sale of the 45%. The net result is a tax-free sale. But even if the tax extenders are not passed, the offer is so good that I think you should move forward with the sale.”
George then asked, “But what happens then? The $1.8 million is in the Sub S corporation, and the $2 million is in the unitrust.”
Clara continued again, “Well, we can move the $1.8 million in cash through to you and Susan, since you recognized gain on that amount. GP now has no assets except the unitrust. Since you have always been Subchapter S, the unitrust can pay income to GP for twenty years, and that income will be paid to you and Clara. If we invest carefully, most of that payout will be dividends and long term capital gain, and may be taxed at a favorable rate. Finally, after the twenty years, the unitrust will be transferred to your favorite charity.”
George was very pleased. He responded, “This looks like a terrific plan! We can sell tax-free, have cash for all our wants and needs, receive a great low-tax income for twenty years and eventually help our favorite charity. Susan and I will enjoy the future with this solution!”
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