Charitable Giving Can Enhance Business Succession Plans

Of all the stratagems and financial modeling that advisors explore when engaged in business succession planning with their clients, one aspect frequently gets overlooked: charitable giving. Thats unfortunate, experts say, because a philanthropic component can reap enormous rewards for owners, their childrenand society.

“Planning is a series of integrated events,” says Randy Fox, a certified financial planner with Wealth Strategies Counselors, Naperville, Ill. “The more you can integrate things at the right time using the right tools, the better the outcome will be.”

Adds Scott Keffer, founder and president of Wealth Transfer Solutions, Pittsburgh, Pa.: “Some of the most tax-efficient approaches combine entity planning, business succession planning and charitable planning. The benefits are not arithmetic but geometric when you put them together.”

Such integrated planning, observers note, yields several benefits that otherwise could not be achieved if the charitable planning were done subsequent to the sale or transfer of the business. Topping the list: tax-avoidance.

By establishing, for example, a charitable remainder trust for a stock redemption plan (or “charitable bailout”), the owner of a C corporation can preserve the business for children while avoiding capital gains on the sale of the business stock.

To that end, the owner transfers a small amount of stock equally to the children by using the annual exclusion and, if necessary, a part of the gift tax exemption. The owner then contributes the balance of the companys stock to the trust in exchange for a lifetime annuity.

Following the transfer, the business buys back (or redeems) the stock for cash, making the formerly minority shareholder children 100% owners of the business. In addition to a life annuity, the technique provides a charitable income tax deduction for a portion of the value of the majority stock given to the trust. When the owner and spouse die, funds remaining in the trust pass to a designated family foundation or charity.

If, however, the owners children are not prepared to take control of the business, the owner could establish a charitable employee stock ownership plan (ESOP). As in the above example, the owner creates a CRT and contributes some portion of company stock to the entity. The ESOP then uses company-provided funds to purchase the owners stock from the trust.

Result: The owner maintains family control of the business and buys time to determine if the son or daughter will be ready to take over the business one day or whether a new owner will need to be found. The CRT again provides a current income tax deduction for the charitable contribution; allows the owner to sell the stock without an immediate capital gains tax; and removes the value of the stock placed in the CRT from the taxable estate.

Beyond the financial advantages, integrated charitable and business succession planning can help lessen frictions between siblings. Michael Kilbourn, president of Kilbourn Associates, Naples, Fla., notes that discussions about transfer of ownership from one generation to the next can ignite passionsparticularly if a son or daughter has, or is believed to have, hidden designs for taking exclusive control of the firm.

“Anytime you have a situation where one child is taking over the business, emotions can run wild,” says Robert ODell, a colleague of Kilbourn and financial advisor at Capital Management Limited, Wheaton, Ill. “When the parents are focused on charitable planning, hostility and fighting between siblings tend to decrease, as everyone has a common purpose.”

Despite the advantages, only a minority of business owners combine charitable and succession planning. Why? In many cases, advisors say, the business owner either is not predisposed to giving or does not believe a charitable component will advance business phase-out objectives.

Or they opt to give in other ways. Tom Henske, a partner with Lenox Advisors, New York, N.Y., says many of his clients sell appreciated securities of companies theyve invested in (other than their own) via a trust. They then use the trusts income stream to fund a permanent life insurance policy to replace the sold assets.

“When presented with the choice of giving away part of the business for charitable purposes and doing charitable planning using other assets, our clients tend to gravitate toward the latter,” says Henske.

One reason may be the perceived shortcoming of the technique in question. Kilbourn notes that the stock redemption plan, while allowing a family to maintain ownership, leaves the younger generation with a lower invested basis in the company than would otherwise be the case. The client might not also like the fact that principal is locked in the CRT for a period of years.

Other clients may view integrated planning as overly long and complex. Given the significant emotional and financial challenges that a business sale frequently engenders, many wonder whether the additional layer of planning will require too much time to implement and maintain.

And that leads to questions. Does one have to file one or several tax returns? Is it necessary to work with a team of advisors over many years to realize the charitable goals? Are the desired results worth the extra effort?

Mike Owens, president of Strategic Legacy Advisors, Lincoln, Neb., says integrated planning neednt be seen as complicated if the producer knows how to communicate the concepts effectively. Too many business succession planners, he observes, lack the necessary presentation skills or dont have an adequate grounding in charitable planning techniques. Upshot: Business owners who otherwise might be predisposed to giving when selling the business arent approached on the subject.

“The better advisors have deep relationships with their clients and explore the depths of who they are,” says Fox. “They open up, and help develop, the philanthropic inclinations of the client.”

When such inclinations are lacking, an appeal to the clients self-interest might prove more effective. Says Owens: “I help people understand that there is a charity in their plan already: the IRS. I use that mantra all the time.”

To judge by recent market statistics, many small business owners have a munificent side, but they give in varied ways.

A 2004 report by DollarDays International notes that 60% of small businesses surveyed offer discounts to nonprofit clients and 52% are involved in charitable fund-raisers. Another 63% donate cash to nonprofits, while 32% prefer to give in-kind contributions. More than three-quarters of small firms (77%) make regularly timed contributions. And 53% annually contribute $500 or more to charity.

A 2003 survey by Cox Family Enterprise Center, an arm of Coles College of Business at Kennesaw State University, Kennesaw, Ga., observes that business owners of firms in operation for at least 10 years and with at least $1 million in sales report giving a median of $50,000.

Skilled advisors can help such active philanthropists establish a legacy during their lifetime using the non-grantor charitable lead annuity trust. The vehicle, say observers, is especially attractive in the current low interest environment. And it will appeal to business owners who dont require the tax deduction provided by a grantor CLAT.

The client places shares of the C corp. into the trust, which provides income to a charitable organization or family foundation starting in the first year (rather than after the owner and spouse die, as in the case of the CRT). After a term of years, the younger generation receives shares of stock, thereby giving them an ownership interest. The technique also zeroes out the gift tax.

“With the non-grantor CLAT, the business owner gets to see his money go to work immediately for charitable purposes,” says Kilbourn. “That can be a powerful motivator.”

While CLATs and other charitable trusts are fine for C corporations, they dont lend themselves so easily to S corps. Advisors caution that a stock transfer to a charitable trust will automatically terminate the S corp.s status, converting the business to a C corp., thereby subjecting the business and shareholders to double taxation on profits from dividends.

One solution, say advisors, is for the S corp. itself to create the CRT and transfer assets, such as appreciated real estate the company owns, to the trust for a term limited to 20 years. The CRT pays the unitrust amount to the corporation, which then distributes the payment pro-rata to shareholders. The income tax deduction achieved by establishing the trust also flows to the shareholders on a pro-rata basis.

Given the many charitable giving and estate planning strategies a business owner might leverage when selling a companyKeffer counts 104 of themno one financial advisor can master the full range, say experts. Hence the need to team up, typically with colleagues at other firms offering complementary skills.

Beyond the core teambusiness succession advisor, CPA and attorneya charitable planner might also tap a money manager, pension actuary, ESOP specialist or mergers & acquisitions (M&A) expert, depending on the requirements of the transaction. Getting them all to work harmoniously can be easier said then doneparticularly if advisors bring biases to the planning table.

“Clients dont necessary want one-stop shopping, where all the necessary expertise resides within a single firm,” says Kilbourn. “What they want are professionals talking to each other and coming to a consensus. But you dont see that often enough.”

Adds Keffer: “Its not unusual for advisors to bring biases to the planning process. They treat with suspicion areas of expertise outside of their universe of understanding.”


Reproduced from National Underwriter Edition, December 10, 2004. Copyright 2004 by The National Underwriter Company in the serial publication. All rights reserved.Copyright in this article as an independent work may be held by the author.