Saturday April 20, 2024
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4.2.2 Asset Sale with Unitrust
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C Corporation Double Taxation
The C corporation is a separate taxpayer. It tracks depreciation and basis of all assets at the corporate level and pays tax on income and gains.
Since the shareholder also has a basis in his or her stock, there is the potential to pay a double tax. Particularly when a C corporation is terminating business, there is tax on the corporate gain at the corporate rate and then a second tax on the shareholder at the shareholder's personal rate.
C Corporation Liquidation
For many closely held C corporations, a time may come when the business assets have been transferred to another entity. Alternatively, the owners may decide to retire and not continue further operations.
After the corporation ceases active operation, substantial liquid assets or appreciated securities within the corporation may remain. This problem creates a challenge. Liquidating in the corporation will subject the gain to tax at both the corporate level and a second time at the shareholder level.
Sale of Assets and Unitrust
If the corporation can be sold as an entity, the preferable alternative is to sell the corporate stock to a new buyer. The shareholder will recognize capital gain at the corporate level. However, due to the nature of corporate assets, many corporations are not saleable as an entity, as purchasers are only willing to buy the assets. By acquiring the assets, the purchasers minimize the risk of assuming liabilities that the corporation had previously created.
One option that reduces (but does not eliminate) the tax on gain is to sell the corporate assets, pay the corporate capital gains tax and then transfer the stock into a charitable remainder trust. This solution has the negative result of paying tax at the corporate level (in which there is no rate reduction), but the positive result of bypassing the shareholder tax and benefiting from a charitable income tax deduction at the shareholder level. The latter two tax benefits may at least offset a substantial portion of the tax that otherwise would be paid on a pure liquidation.
Example 4.2.2A Timber Sale and Unitrust
John Wilson was involved in the timberland industry his entire career. He acquired a parcel of approximately 300 acres of timber. Since he was operating a corporation involved in various aspects of the timber industry, he purchased the timberland with corporate cash.
When John passed away, he transferred one-third of the corporation to each of his three children, Arnold, Bill and Clara. Arnold, Bill and Clara owned the property for over 30 years, and merely maintained it through minor cutting.
After Arnold, Bill and Clara retired, they thought it would be appropriate to sell the property. The timber was now between 40 and 50 years in age and the value of the property had increased dramatically.
However, the three children had different goals. Two of them wanted to be cashed out and one wanted to continue to own the corporation and to use the cash proceeds to engage in other business transactions.
Both the corporation and the timber were offered for sale. Predictably, the bids came in for the timber and not for the corporate entity. The top bid was just in excess of $5 million for the timber and land.
The C corporation sold the timber and land for $5 million. After payment of tax at the federal corporate rate, approximately $4 million remained. Clara then took her distribution in cash, and paid tax at capital gains rates on complete redemption of her stock.
Arnold transferred his shares of stock into a charitable remainder unitrust for himself and his spouse Pat. The unitrust sold the stock for $1 million cash to the corporation. Arnold bypassed the gain, and received a charitable income tax deduction.
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Case Studies on Asset Sale with Unitrust
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.
Pecos Bill and the Silver Saddle:
Pecos Bill hailed from West Texas and loved the open range. Bill learned to ride horses almost as soon as he could walk. While still in his teens, Bill started to build saddles. By age 25, Bill was one of the premier builders of silver and leather saddles.
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