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Monday, April 29, 2024
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Case Studies |
Another Tale from ESOPs Fables, Part II
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Case:
In Part I, we were introduced to Eric and Stephanie Hawkins, who are the sole shareholders in a Seattle printing business. They are looking to divest themselves of ownership in the company and transfer shares of stock to their employees through an employee stock ownership plan (ESOP). One of their major goals is to transition away from the fast-paced lifestyle of owning a business and spend more time with each other and their two children. Their dream has been to own a bed and breakfast and they have taken a major step in this direction by purchasing a five-acre parcel of property on San Juan Island.
What we did not learn about Eric and Stephanie in Part I is that they are very active in community work and have been extremely generous with their financial resources. They have established a donor advised fund at the local community foundation and have been active in working with the city's homeless population. They eventually would like to make a substantial contribution to three local charities that support the homeless, and have been discussing with their attorney the aspects of utilizing a charitable remainder trust to fulfill this objective.
Also, they desire to provide an education fund for their two children. The children are currently enrolled in private schools and Eric and Stephanie would like to provide funding not only for their current private education, but for college as well. Also, as stated in Part I, they are very concerned about the welfare of the children should something happen to them in the event of an unexpected tragedy. Stephanie's sister and brother-in-law have agreed to be guardians of their children should such a situation occur, but they are still concerned about the children's financial situation. Also, estate taxes are a consideration since they have an estate valued over $22.36 million.
Question:
Having just set up the ESOP a couple of years ago, Eric and Stephanie have sold over $500,000 of their stock to the ESOP. They have used most of these funds, net of capital gains taxes, to retire a good portion of the debt they incurred to purchase the property on San Juan. They would like to sell much more of the stock to the ESOP, but since their basis in the stock is almost nil, they are concerned about the capital gains taxes. They certainly did not like the idea of paying $100,000 in tax on the previous sales! Also, Eric and Stephanie are concerned about the welfare of their children should something happen to them and would like to make sure the children will be well cared for in the event of an unexpected tragedy.
Solution:
All of these concerns have been expressed to their estate planning attorney, and in a recent meeting, a number of proposals were discussed. Eric and Stephanie are pleased that their attorney is an expert in charitable estate planning, as their charitable objectives are primary in planning for the future of their children and in the final disposition of their estate. After a number of lengthy discussions, they adopted the following proposals:
1) An education unitrust would be established for the children for a 15-year term. The unitrust would be funded with $250,000 of the printing company stock, which would then be sold to the ESOP. The established payout rate of the trust would be 7% and, therefore, the trust would begin to pay $17,500 per year to the two children. Any funds not needed for their current educational needs would be invested on behalf of the children for future college needs. Eric and Stephanie would retain the right to revoke the children's interests in the trust and, therefore, no gift taxation would result. The three charities whose missions are to help the homeless would be the remaindermen of the trust upon its the termination.
2) Eric and Stephanie would establish a two-life charitable remainder trust with a payout rate of 5% with $1,000,000 of the company stock. Once again, the stock would be sold to the ESOP. The tax savings and the income from the trust would be used to purchase a second-to-die life insurance policy on Eric and Stephanie in the amount of $1,000,000. The life insurance trust would eventually benefit the two children and the unitrust would benefit the aforementioned charities.
3) Eric and Stephanie then would sell outright to the ESOP an additional $500,000 of stock, the proceeds of which would be used to pay off the remaining debt on the bed and breakfast property and provide capital for renovation.
The benefits of this planning are many. Eric and Stephanie have divested themselves of $2.25 million in stock in the printing company. However, they still retain majority control. The 15-year term unitrust yields a charitable income tax deduction of $87,740 and the two-life unitrust yields a tax deduction of $200,920, for total deductions of $288,660. Therefore, the tax savings more than offset the tax on capital gains.
In addition, there are substantial benefits to charity and their children. Assuming an 8% trust net investment return, over $287,000 would pass to charity from the 15-year trust and over $3.0 million would pass to charity from the two-life trust (based on the Hawkins' life expectancy). The children's education is provided for, estate taxes are minimized as a result of utilizing a life insurance trust, charitable objectives are fulfilled and the children's financial future is secure through savvy planning.
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