Thursday March 28, 2024

4.2.3 Stock Sale with Unitrust

Stock Sale with Unitrust

Sale and Unitrust:  A C corporation may be subject to a double tax.

Avoiding a Prearranged Sale:  The major challenge in selling stock to a larger corporation is to avoid a prearranged sale.

Sale of a C Corporation:  There are four specific steps to sale of a business.

Unitrust Design:  If the business owner desires to maintain control as long as possible, there are several steps that can be taken.

Sale and Unitrust


A C corporation may be subject to a double tax. There is potential tax at corporate tax rates on the gain inside the corporation and at the shareholder capital gain rate on the sale of stock by the shareholder.

However, if the C corporation is the type of business that may be sold as a corporation, generally to a larger C corporation, a very attractive option exists. In this circumstance, the taxpayer may transfer part or all of the C corporate stock into a charitable remainder unitrust. If the stock is transferred to a unitrust and sold by the unitrust to the purchaser, there will be a complete bypass of capital gain.

Avoiding a Prearranged Sale


The major challenge in selling stock to a larger corporation is to avoid a prearranged sale. In order to bypass the capital gain, there must not be a prearranged sale when the stock is transferred into the unitrust. The prearranged sale is generally avoided if there is no binding obligation for the trustee of the charitable trust to sell to a purchaser. Rev. Rul. 78-197, 1978-1 C.B.83.

Business owners understandably wish to be in control of the sale process. Thus, it is quite possible that the business owner will prefer to delay the transfer of the stock into the charitable trust as long as possible. While this strategy can be successful, there is an increasing risk level as the sale progresses.

Sale of a C Corporation


There are four specific steps to sale of a business. At each level, the risk level increases.

First, there is generally a period of negotiations with offers and counter offers made orally. The risk is very low in transferring the stock at this time. Second, there frequently is a letter of intent. The letter of intent is signed by both parties and describes the general terms for the sale of the corporation. In most cases, it is not legally binding. The risk level is again quite low when the letter of intent is signed.

Third, there is a vote by the directors. If the directors hold more than 50% of the stock, the vote by the directors is equivalent to a vote by the shareholders. However, if the stock is widely held, the vote by the directors may raise the risk, but it frequently is permissible to transfer the stock into a charitable trust even at that point.

Fourth, there is a vote by the shareholders. After 51% or more of the shareholders have voted to accept the offer, then the gain has "ripened" and may not be avoided by transfer of stock either outright to a charity or to a charitable remainder trust.

In the Ferguson case, the shareholders had indicated an intent to transfer the stock in August of 1988. However, due to a delay in receiving approval from a large financial services company, the shareholder vote was conducted before the gift to charity. On August 30, 1988, 85% of the shares had been voted in favor of the merger. When the actual stock was gifted to charity on September 12, 1988, over 95% of the shareholders had voted in favor of the transfer. Since over 51% of the vote had been tendered, the court determined that it was now too late to bypass the gain.

As a result of the Ferguson decision, the 51% rule is now clearly important. If stock is to be transferred into a unitrust, the gift must occur before 51% of the shareholders have voted to accept an offer.

Unitrust Design


If the business owner desires to maintain control as long as possible, there are several steps that can be taken. First, the business owner should be cautioned not to sign any legally binding agreement prior to transfer of stock into the trust. A letter of intent may be permissible after review by counsel, but any other agreement should not be signed. Second, there should be a third-party trustee of the charitable trust. The donor and spouse should not serve as initial trustees of the trust. If the donor does not prefer a corporate trustee, then a third-party private trustee may be selected. This third party trustee is key to demonstrating that there has been a transfer of stock to the third-party prior to the sale.

Third, after the negotiations have proceeded to a point at which the shareholder believes that a sale is imminent, the stock is transferred to a unitrust with the third-party trustee. Normally, a FLIP unitrust will be used because the stock is not producing enough income to pay the trust beneficiaries. After the C corporation stock is sold by the trustee to the new buyer, the trust will FLIP to a straight trust the following January 1.

After the stock is transferred to the charitable trust, it is preferable to wait a reasonable period of time, perhaps four to eight weeks, prior to completing the transaction. This also allows the third-party trustee an opportunity to explore sales to other potential purchasers and demonstrates the lack of prearrangement for the sale.

Upon sale of the stock to the new buyer, the trust receives the sale proceeds. The donor benefits from a bypass of capital gain and receives a charitable income tax deduction based upon the Applicable Federal Rate, the unitrust payout rate and the ages of the donors.

Example 4.2.3A An Environmentally Sound Sale

Alex and Bob attended university together. After working in different companies for several years, they decided to start a new company to produce environmental devices.

Thirty years ago, Bob believed it would be beneficial to develop devices to measure industrial pollution levels. Alex and Bob worked hard over the years and built a small high-technology company. The company produces several devices for measuring industrial pollution.

As the Environmental Protection Agency has increased requirements for limiting pollution, the demand for the company's products also has increased. The business has grown and now has over 70 employees.

A large company is interested in acquiring Alex and Bob's C corporation. Since they now are age 62 and plan to retire during the next three years, they have entered into negotiations for purchase of the company.

Bob and his spouse Kris have always had a close relationship with their local charities. They explored options with their CPA and discovered that it would be possible for them to sell tax free. They plan to create an insurance trust that will provide a very substantial inheritance for their two children.

During the negotiations, Bob and Kris transfer their stock into a 6% charitable remainder unitrust. The unitrust will make payments to them for their two lives and then the principal will be transferred to their favorite charities. Since Bob and Kris also have a large pension plan and own their home, they decide to transfer all of their stock into the charitable trust.

The charitable trust, with their financial advisor as trustee, then offers the stock for sale to the large company. The trust receives $2 million from the large company for the stock.

Since their cost basis in the stock was $1,000, Bob and Kris bypass the gain and save almost $300,000 in capital gains tax. They also receive an income tax deduction of $700,000. Since this is an appreciated tax deduction, their deduction will be limited to 30% of their adjusted gross income each year. Fortunately, the deduction may be stretched over as many as six years.

Bob and Kris are pleased with the plan. They bypassed all of the capital gain, and enjoy substantial tax deductions. In addition to the IRA income that will start next year, Bob and Kris will receive approximately $120,000 annually from the charitable remainder unitrust. If the trustee invests in an equities portfolio, perhaps half of this payout can be distributed at 15% dividend and capital gain rates. Finally, the additional income after tax will provide them with more than sufficient resources to fund the insurance trust for the inheritance of their two children.

Case Studies on Stock Sale with Unitrust

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.

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.

Southern Brat Unitrust and Sale Bailout:   Peter and Sue Olson were raised in the great North Country. After college, they were married, and Peter accepted a position with one of the nation's largest discount stores.


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