Charitable planning has long been a tool of the trade for advisors looking to reduce high-net-worth clients’ income and estate tax obligations. What few of these advisors realize, however, is that such planning lends itself equally to the corporate space, where it can yield even greater dividends.
“Much of the law with respect to wealth replacement trusts for individuals applies very readily to the corporate setting,” said Gerald Treacy, president of Arcline Consulting, Poulsbo, Wash., who spoke on the topic during an education workshop at the Association for Advanced Life Underwriting’s annual convention, held here recently.
“Businesses have blown hundreds of millions of dollars in bottom-line profits by not recognizing these tools,” he said.
These patent-pending techniques can substantially reduce tax liabilities that companies would otherwise incur when selling highly appreciated assets. Given the higher tax rate to which corporations are subject compared to the capital gains rate that applies to individuals–35% or more vs. 15%–the appeal of corporate charitable planning is all the greater, said Treacy.
To illustrate, he described a corporation A that transfers highly appreciated land worth $50 million and has a cost basis of $2 million to a business asset sale trust. The trust sells the land, saving the business $16.8 million in tax that would otherwise be paid if the company sold the asset outside the trust.
The corporation gets a roughly $5 million charitable deduction for creating and funding the trust, secures from the vehicle 20 years of income payments, and uses a portion of the tax savings to acquire life insurance on key executives’ lives, thereby “making up” for trust assets that later pass to charity.
At the end of the 20-year term, the trust distributes the assets to a corporation foundation created by the business. And the business receives proceeds of the life insurance policies.
“Life insurance proceeds are a huge advantage of the trust because they make up for the [asset] loss,” said Treacy. “Also, if named an irrevocable beneficiary of the trust, the foundation can seek financing from a bank on the strength of future distributions.”
In addition to C corporations, pass-through entities (such as S corporations, LLCs and partnerships) also can leverage the trust. The vehicle’s advantages for such businesses are still greater, said Treacy, because the tax benefits flow directly to the business owners/members.
Similar in function to the business asset sale trust is the mergers and acquisition trust, which can minimize tax consequences for acquired businesses. In Treacy’s example, a business to be sold transfers highly appreciated assets to an M&A trust, which sells the assets as part of the merger or acquisition, saving the purchased business $15.8 million in tax.
Treacy cautioned, however, that the trust must be established well before the sale of the business (whether it is a C corp. or pass-through entity) to ensure favorable tax treatment by the Internal Revenue Service.
“This technique works not just for firms that are sold but also those that are in an acquiring mode,” said Treacy. “The strategy may well save an M&A that would otherwise be too costly.”
Corporate charitable vehicles also can be used in executive compensation planning. A chief advantage of such planning, Treacy observed, is the ability to offer executives retirement benefits at low cost.
To that end, a business can establish an executive compensation trust that is structured like the aforementioned trusts. The difference is that the trust’s 20-year income stream will be used to fund creditor-protected compensation for the executive. And, as with all his examples, Treacy noted, the foundation’s work can generate goodwill and favorable publicity for the business.
“Once again, we’re killing two birds with one stone,” he said. “We’re avoiding tax that would otherwise be paid on the sale of appreciated assets. And we’re providing a nice funding mechanism for the executive’s compensation.”
Treacy warned attendees, however, against designating the executive as the trust beneficiary, as this would constitute recognition of income for the executive.
One technique available to companies planning for high-income years, said Treacy, leverages business charitable equity options. A business issues these CSOs to a selected charity, including the business’s own charitable foundation. The foundation thereby is entitled to receive an equity interest in the business at a bargain purchase price in a future year.
Upon a triggering event (e.g., the unveiling of a new product manufactured by the business), the company transfers the equity interest to the charity using a “strike price” below the fair market value of the equity interest. The business thus secures a charitable deduction to offset the expected high income from the product’s release.
Other corporate charitable planning strategies detailed by Treacy included the executive life estate plan, an executive recruitment and retention technique; and the business yield enhancement trust, which can be used to liquidate a highly appreciated, low-yield asset in order to increase yield.
“There are so many arcane and interesting corners of the tax law that businesses can use to dramatically boost their bottom line,” says Treacy. “These corporate charitable planning vehicles represent a golden opportunity for them.”