The charitable stock bailout is an attractive strategy for business owners who want to leverage their companies’ closely held stock for achieving charitable planning objectives. The 2 case scenarios described below show how to secure 2 of them: charitable gifting that avoids using personal income; and gifting for attaining succession and estate planning objectives.

Scenario 1

The first case is one in which the owner of the closely held stock wishes to make a contribution to charity, but does not wish to use personal funds for that contribution.

Consider the following case pattern:

1. Mr. Jones, age 60, is the 100% owner of Jones Enterprises, a C corporation.

2. The business is valued at $4 million (fairly appraised) with a good cash reserve and strong cash flow. The corporation is experiencing an accumulated earnings tax problem.

3. Jones is in a personal combined income tax bracket of 40%.

4. Jones has been an active alumnus for many years with his university, which has approached him about making a major gift to fund a project.

5. He would like to make a gift, but does not want to use his personal income to fund the gift.

Mechanics of the charitable stock bailout

1. Jones gifts $100,000 worth of Jones Enterprise to his university, an outright gift with no strings attached.

2. At a future date, the university will offer its stock in Jones Enterprise (no pre-arranged obligation) back to the corporation; the corporation uses its cash reserve to purchase its own stock.

What is accomplished

1. Jones receives a $100,000 tax deduction (equal to the gift’s present value) and a tax savings of $40,000 (40% of $100,000).

2. Jones spends no cash personally.

3. Jones still controls the company. And the university has cash for its project.

4. Jones has avoided dividend treatment of stock the corporation can redeem for cash.

Jones can use this strategy to make ongoing gifts as long as the gifts are complete and irrevocable; and as long as they require no formal or informal agreement, nor retention of substantial rights, such as voting rights.

Scenario 2

The second case is one with which many of us as financial advisors are confronted. How does the owner of a closely held corporation pass on the ownership of stock to key employees, use the wealth for retirement purposes, reduce the potential tax liabilities of the transfer and treat family members fairly?

The use of the charitable stock bailout strategy, (along with other financial tools), can provide a useful tool to accomplish these objectives. Consider the following case pattern:

Assumptions

1. Mr. and Mrs. Field are 55, married and have 2 children (neither is involved or interested in Mr. Field’s business).

2. Mr. Field owns 100% of Field Enterprises, a C corporation, which is valued at $5 million (basis of $1 million) and has a healthy cash reserve and consistent strong cash flow. Given the business’ current financial plan, Field Enterprises’ stock value would be subject to estate taxes.

3. With the current plan, other assets owned by the Fields would be exempt from estate taxes.

4. The Fields are somewhat philanthropic.

5. The Fields are in a combined 40% income tax bracket.

Objectives

1. Eliminate taxes on the estate.

2. Avoid capital gain taxes on the sale of Field Enterprises.

3. Pass Field Enterprises on to key employees.

4. Give up control of the company at age 60, work part-time at age 65 and retire at age 70.

5. Provide for retirement income.

6. Treat children equally and fairly.

Suggested strategy using the charitable stock bailout plan

1. Mr. and Mrs. Field create a charitable remainder uni-trust (CRUT) and make gifts of $500,000 per year for 10 years of Field Enterprise stock.

2. Mr. Field creates an employee stock ownership plan and the ESOP purchases $500,000 of Field Enterprise stock from the CRUT each year for 10 years.

3. Field Enterprise borrows $500,000 per year for 10 years from a lending institution and makes a $500,000 deductible contribution to the ESOP for 10 years. The CRUT could provide collateral if necessary.

4. Mr. and Mrs. Field create a wealth replacement trust (irrevocable life insurance trust) and purchase a $5 million second-to-die policy. Policy premiums are funded through cash flow from the CRUT, current cash flow and tax savings generated from a current income tax deduction.

5. Mr. Field establishes a 5-year consulting agreement with Field Enterprises at age 65.

What is accomplished

1. Mr. Field avoids capital gains tax on the sale of Field Enterprises, a savings of $600,000 using a current 15% capital gain tax rate.

2. Mr. Field removes Field Enterprise stock from the estate over a 10-year period. That yields a savings of $2,250,000 in taxes, assuming he occupies the 45% federal estate tax bracket. This amount goes to charity.

3. Mr. Field transfers stock and control of the company to key employees over 5 years.

4. The transfer provides additional retirement income of $250,000 per year, assuming a 5% CRUT payout (assuming no loss or gain of principal).

5. The transfer creates a tax deduction of $1,435,000 and a tax savings of $574,000 over 10 years, assuming an IRC Section 7520 rate of 6.20% and a 40% tax bracket.

6. Mr. Fields signs a consulting agreement with the company that allows him to continue working in a part-time consulting capacity.

7. The wealth is replaced and children are treated equally.

8. Substantial gifts to charity are enabled at the second death of Mr. and Mrs. Field.

While not discussing all the details and variables involved in a charitable stock bailout, this article should provoke the reader into considering charitable planning techniques when working with clients. As always, planners should consult with the client’s legal and tax advisors when formulating recommendations.