Using your clients’ social capital can help solve their conflicting goals. Rather than having their tax dollars go to the government, we make those dollars go to a favorite charity and, in the process, solve a client problem. For purposes of this article, we’ll focus on two: creating a business exit strategy; and buying out a minority partner.
If the client’s objective is to reduce gift and estate taxes on assets that would pass to heirs, then a charitable lead trust or CLT is one solution. This split-interest trust is the vehicle that provides an income interest to a charity and a remainder interest (in the future) to non-charitable beneficiaries. An alternative solution, the charitable remainder trust or CRT, works in reverse: It pays a percentage of trust principal to named individuals and eventually distributes a remainder interest to charity.
Use of planned giving for an exit strategy or succession plan
Consider a client who owns a corporation and wants to pass the business to a child employed in the firm. In this example, the basis is low and the current book value is substantial, so there would be a large capital gains tax to pay. The client might also have to finance the sale to the child. The client’s child additionally needs to be a shareholder and the cash flow of the business should be good.
Using the CRT
To effectuate the transfer to the child, the business owner creates a charitable remainder trust, donates the stock to a charity with a qualifying stock redemption agreement. The business then repurchases the stock. This technique has several advantages:
(1) Capital gains tax is eliminated on the donated shares;
(2) The company redeems the shares from the charity and keeps the business in the family, since the remaining stockholder is the child;
(3) The charity has the cash to purchase an annuity for the donor;
(4) The child is now the remaining shareholder and owns the business;
(5) The charity has the future benefit of a sizable donation (also called the remainder interest);
(6) The donor has retirement income for the term of the trust, usually 20 years or for the donor’s lifetime; and
(7) With the income tax savings from a charitable deduction and the annual income from the CRT, a life insurance policy can be purchased through an ILIT or wealth replacement trust to effectuate estate equalization among all the children or used to replace the value of the donated asset.
More flexibility can be built into this plan design by incorporating voting and non-voting stock. This structure can accommodate many family situations.