Wednesday April 24, 2024
|
|
|
|
|
4.12.1 Public Stock
|
|
|
Stock Returns and Appreciation
During the past century, public stocks held over a long period of time have proven to be the safest type of investment with the greatest return. While it is certainly true that stocks have fallen rapidly and dramatically for the periods 1929-1932, 1973-74, 1987 and 2000-2002, the long-term stock investor has been very successful.
But what is long term? For those who hold the stock for 10 years or longer the returns start to average out. After 30 years, the nominal total return rates range from 8% to 11% for all periods since 1940.
Return rates for a stock are composed of dividends and appreciation. During the past two decades, dividends have declined in value and the greater benefit has come from appreciation. The other factor to consider is inflation. If one subtracts inflation from the total return of a stock, the remaining amount is the "real return." This is the actual increase in economic value.
For the period 1946-2001, the real return was 7.1%. This real return percentage has been consistent for over 200 years. The real return from 1802-2001 was approximately 6.9%. Finally, during the great bull market of 1982-2001, the real return was 10.5%.
While stock returns can vary substantially, the total returns for the past 70 years have been approximately 10.5%. During that time, inflation equaled approximately 3.4%, leaving a real return of about 7%.
Company Size and Style
Stocks generally are characterized based on the size of the company and the method or style of operation. Stock categories are based on the total market value, or capitalization. There are large-cap stocks, mid-cap stocks and small-cap stocks. Large-cap stocks typically have less volatility while small-cap stocks are more volatile but historically have returned 1-2% more than the large-cap stocks.
The second characteristic is related to the style or strategy. Stocks are generally growth, blend or value stocks. A growth company is frequently a new company and may pay few or no dividends. Because the company pays no dividends, all of its growth affects the value of the company and the stock value grows accordingly. A value company typically is in a mature industry, such as pharmaceuticals, utilities or financial services. Many value stocks pay a 3-5% dividend. Because value stocks pay a dividend, they tend to be less volatile but may appreciate at a slower rate than growth stocks. A blended return stock is balanced between growth and value.
Capital Gains and Dividends Tax Rates
Because of the increase in stock prices over time, many individuals currently hold appreciated stock. If the stock has been held for over one year, the stock may be sold, with the gain taxed at favorable capital gains tax rates. If the stock has been held for one year or less, however, then sale of that stock produces short-term capital gain. This short-term capital gain is taxable at ordinary income rates.
Long-term capital gains tax rates have varied substantially over the past few decades. In 1988, the capital gains tax rate was 33%. This rate was changed to 28% in 1990, 20% in 1997 and 15% in 2003.
In 2003, a significant change to dividend tax rates occurred. Prior to 2003, dividends were taxed at the same rate as other ordinary income. However, beginning in 2003, dividends payable from U.S. companies and foreign companies listed as American Depository Receipts (ADRs) on the New York Stock Exchange are taxable at long term capital gains rates.
Gifts of Stock
Individuals and charities receive significant benefits when individuals make gifts of stock. For example, if a person sells a share of stock and then writes a check to a charity, the person must pay capital gains tax. Only the amount after paying the capital gains tax will then be available for a gift to charity.
Alternatively, if a person transfers a share of stock directly to the charity and permits the charity to sell the stock, the capital gains tax is avoided. The donor makes a larger charitable gift and receives a charitable deduction for the full fair market value of the share of stock.
Transfers of Publicly Traded Stocks
Publicly traded stocks may be held as certificates or in electronic form. If a donor holds actual certificates, there are two ways to transfer the stocks. The first is for a donor to endorse the stock certificates, obtain a signature guarantee from a bank or qualified securities company representative and transfer the certificates to charity. Alternatively, the donor may use a stock certificate and have his or her signature guaranteed on the stock power. If the stocks are to be mailed to the charity, the certificates are transferred in one envelope and the stock power is mailed in a second envelope.
The date of transfer is the date of delivery. If the transfer is by mail, it is the date of the postmark. Reg. 1.170A-1(b). If the certificate or stock power is transferred by a qualified courier, it is also effective as of the date of dispatch. Rev. Proc. 97-19, 1997-10 IRB 55. Private services that qualify under Sec. 7502(f) include Federal Express, DHL, Airborne Express and United Parcel Service.
Stock Assignment Separate from Certificate
FOR VALUE RECEIVED, I/we hereby sell, assign or transfer to (name and full address of Charity) (# of shares) of the Common Stock of (Name of Corporation) , standing in the undersigned's name on the books of said corporation represented by Certificate No.(s) ____ herewith, and do hereby irrevocably constitute and appoint (name of Charity and person at the Charity who will handle the transfer) as attorney to transfer the said stock on the books of said Corporation with full power of substitution in the premises.
Dated: ___________________
Name of Registered Holder: (list name of registered holder exactly as it appears on the face of the certificate)
Signature of Registered Holder: _______________________
Name of Registered Holder: (list name of registered holder exactly as it appears on the face of the certificate)
Signature of Registered Holder (if more than one): ______________________
Affix Medallion Guarantee Imprint
The second option is for the securities to be owned in an electronic account. Many securities firms hold their securities in street name. The transfer is accomplished through the Depository Trust Company (DTC). The DTC transfer is started when the donor's agent or broker receives written instructions from the donor. Following the written instructions, the agent initiates the DTC transfer.
The easiest DTC transfer is to an account for the charity with the same brokerage firm. With a DTC transfer, the effective date of transfer is the date of transfer into the account of the charity. Reg. 1.170A-1(b). This transfer can be directed and take place the same day if an account for the charity has been previously established.
Valuation of Charitable Deduction
The value of a charitable gift of publicly traded stock depends on whether the stock is considered a long-term capital asset or a short-term capital asset. Capital assets held less than a year and a day are short-term capital assets.
Gifts of short-term capital assets are deductible at cost basis. Sec. 170(e)(1)(B)(ii). Therefore, if a donor has held a stock for less than a year and a day, the donor will receive a deduction based on the cost basis, rather than the fair market value of the stock.
However, gifts of stock held more than a year and a day are deductible at the mean between the high and low prices of that stock on the date of transfer. Reg. 20-2031-2(b)(1). If stock is transferred on a date when there is no trading, then the mean is averaged for the prior and subsequent trading days. The averaging method also adjusts the mean according to the number of pre-gift and post-gift days.
Stock for Charitable Gift Annuity
Public stock is an excellent gift in exchange for a charitable gift annuity. It is easily transferred and readily converted to cash by the charity.
As with all gift annuities, the payout rate and charitable deduction depend upon the age of income beneficiary or beneficiaries. When appreciated stock is used to fund a gift annuity, however, it is important to consider how the appreciation, or built-in capital gain, is treated. First, when appreciated stock is used to purchase a gift annuity for the donor, a portion of the capital gain is allocated to the gift portion of the annuity and completely bypassed. Second, the balance of the capital gain is allocated to the annuity contract value (the fair market value of the stock less the charitable deduction).
If the donor or donor and spouse are the annuitants, the capital gain allocated to the contract value is reported over their life expectancies. An exclusion ratio determined by Internal Revenue Service tables and rates determines the amount of each payment that is excluded from ordinary income. A portion of this excluded amount is the annual capital gain that the annuitant must recognize. The payout from a cash annuity would be first ordinary income and then tax-free payouts. With an appreciated stock gift annuity, the payout is first ordinary income, then capital gain and finally tax-free payout. The capital gain may not exceed the tax-free portion. Reg. 1.1011-2(a)(4).
As is true with a cash gift annuity, the capital gain and tax-free portions are payable for projected life expectancy. If the annuitants live past their projected life expectancy, all payouts will thereafter be ordinary income.
Example 4.12.1A Appreciated Stock Gift Annuity
John and Mary Stock bought stock in a home improvement company a number of years ago for $40,000. The company has done well and their stock is now valued at $200,000. Since John and Mary are receiving less than a 1% dividend from the stock, they are very interested in substantially increasing their income.
John and Mary transfer the $200,000 in stock by giving written directions to their broker. The broker initiates a DTC transfer the same date. John and Mary also sign a gift annuity agreement and place that in the mail to the charity.
The gift annuity is funded with an amount equal to the mean between the high and the low on the date of transfer. The charity immediately sells the stock and transfers the cash to its reserve fund. Based on their age, John and Mary receive a 5.7% annuity. Under IRS tables, they receive an income tax deduction of $70,863. This is an appreciated-property-type deduction, since it was funded with appreciated stock, and may be used up to 30% of their adjusted gross income. Any excess may be carried forward over as many as five years.
The annuity pays 5.7%, or $11,400 based on the $200,000 value. The annuity payout is divided into an ordinary amount and the balance. The ordinary amount is $3,523. The balance is divided into a $6,299 capital gain amount and $1,578 tax-free payout. At their estimated life expectancy, the capital gain will have been fully reported and future payments will be fully ordinary income. If they should both pass away prior to their projected expectancy, there would be an income tax deduction on their final return for the unrecovered tax-free amount. John and Mary receive the $11,400 payments until both of them pass away. At that time, there is a very substantial gift to their favorite charity.
Public Stock to Charitable Unitrust
Another excellent option for individuals who hold a substantial block of stock is to transfer it into a charitable remainder trust. Since public stock is readily sold, it will usually be the choice of the donors to select a standard, or Type I, unitrust. This unitrust makes the unitrust payments from income and, if necessary, from principal. However, donors often select a 5% or 6% standard unitrust, so there is the potential of growth in the future.
The three major benefits of the unitrust are the ability to bypass capital gain, an increase in income and a charitable deduction.
Example 4.12.1B - Appreciated Stock To Unitrust
Bill and Helen Wilson bought stock in a small struggling electronics company 25 years ago. After going through a very difficult period, the small company developed new products and was subsequently acquired in a stock-for-stock exchange by a much larger company. The initial $1,000 investment by Bill and Helen is now large company stock valued at $500,000. However, the large company is paying less than 1% in dividends. Bill and Helen are retired and would like to increase their income.
Bill and Helen ask their attorney to draft a standard unitrust paying 5%. They select 5% because, after research and discussion with a financial planner, they realize that this withdrawal percentage will nearly always result in growth of the principal. Even if there is a bear market in the early years of the trust, a 5% payout rate is nearly certain to result in growth over the estimated 22.7 years for the trust payouts.
After the trust is drafted, Bill and Helen direct their broker to initiate a DTC transfer of their shares of stock to themselves as initial trustees of the unitrust. After receiving the stock in the trust brokerage account, they immediately sell and diversify into a portfolio of 60% stocks and 40% bonds. They believe that this portfolio, which has historically earned nearly 9%, will earn an estimated 8% net total return for their lifetimes.
They are able to bypass the $499,000 capital gain. They receive a charitable income tax deduction of $202,870. They understand that the appreciated property charitable deduction may be used to 30% of adjusted gross income, with up to a five-year carry forward of any excess.
Bill and Helen receive income of $25,000 in the first year. This is approximately a $20,000 increase over their prior income. Over their 22.7 years of life expectancy, they can anticipate receiving nearly $800,000 in payouts. With the investments, part of the payouts will be interest from bonds taxable at ordinary rates and part will be payouts taxed at capital gain rates. With growth of the trust, their 5% income will also grow proportionately. When they both pass away, there will be a substantial gift to their favorite charity.
|
Case Studies on Public Stock
In-Kind Distributions to Donors, Part 1 of 2:
Jim Thompson, a retired engineer, and his spouse Logan Thompson, a retired nurse, are currently considering funding a term-of-years charitable remainder unitrust with Americans for the Arts charity. Americans for the Arts is raising money for the construction of a new building which would house a state-of-the-art theatre and museum. The Thompsons, while retired, are active investors and have amassed quite a fortune over the past few years. In particular, they have investments in numerous established technology companies that have quadrupled in value over the past two years. They would like to use $800,000 of stocks with a cost basis of $100,000 to fund a five-year CRUT with a 15% payout. However, they believe these companies are great investments with acceptable risk and prefer that the trustee of the CRUT not sell these stocks. Furthermore, the Thompsons would like their CRUT payouts to be the actual stock - an in-kind distribution - as opposed to cash payouts. Thinking creatively, the Thompsons then wonder if such a distribution would avoid capital gain since technically the stock has never been sold.
In-Kind Distributions to Charity and the Reverse Four-Tier, Part 2 of 2:
Jim Thompson, a retired engineer, and his spouse Logan Thompson, a retired nurse, are currently considering funding a term-of-years charitable remainder unitrust with Americans for the Arts charity. Americans for the Arts is raising money for the construction of a new building that would house a state-of-the-art theater and museum.
Stock Unitrust Payouts to Donors:
Jim Thompson, a retired engineer, and his wife Janet Thompson, a retired nurse, are considering funding a term-of-years charitable remainder unitrust (CRUT) to benefit their favorite charity. Their favorite charity is raising money for the construction of a new building which would house a state-of-the-art theatre and museum. The Thompsons are active investors and have amassed quite a portfolio over the past few years. In particular, they have an investment in a medical services company that has quadrupled in value. They would like to use $800,000 of stock with a cost basis of $200,000 to fund a five-year CRUT with a 15% quarterly payout. However, they believe this company is a great investment with acceptable risk and prefer that the trustee of the CRUT not sell this stock. Furthermore, the Thompsons would like their CRUT payouts to be the actual stock – an in-kind distribution – as opposed to cash payouts. Thinking creatively, the Thompsons then wonder if such a distribution would avoid capital gain taxation since technically the stock has never been sold.
Can the Thompsons accomplish their goal of a tax-free 'in-kind' distribution of their technology stock? What are the tax consequences to the CRUT and to the Thompsons with this transaction?
Sam Storeowner and the Tax-Free Buyout:
Sam Storeowner was having coffee at Small Town Café when his friend Bob Banker walked into the café. Bob motioned Sam to a booth in the back and said that he wanted to talk to Sam. It turns out that Bob and several friends were in the process of obtaining a charter for a new bank. They were contacting a number of business owners in town and offering them the opportunity to invest.
Time for a Smooth Landing:
John and Mary Gonzalez are both age 75. Fifteen years ago they flew south on vacation. During the flight, the flight attendant was in John's words "the best stand-up comic" he had seen. John thought, "If this crew has so much fun, the company will do well." So John and Mary bought stock in the airline.
Zero Tax Greenco Bailout, Part 1:
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.
|
Private Letter Rulings
PLR
9623018 Restricted Stock to Unitrust IST:
Many officers of corporations that go public receive stock restricted under Rule 144 of the 1934 Securities and Exchange Act. In this PLR, an officer was permitted to transfer stock into a two-life unitrust, even though it still had the restricted status. The donor is self-trusteeing the trust, but a bank is an "Independent Special Trustee" for the purpose of ascertaining market value of the stock.
|
|
|
|
|
|
|
|
|
© Copyright 1999-2024 Crescendo Interactive, Inc.
|
|
