Gift Planning Tips

ESOPS and Charitable Gift Arrangements

Business owners who do not plan to transfer their companies to family members sometimes sell the company to their employees — an act that can trigger capital gains taxes.  Another option, one that defers capital gains taxes, is a sale through an employee stock ownership plan (ESOP).  An ESOP is a defined contribution plan that must meet the requirements of Code §401(a).  Contributions to the plan are tax-deductible by the employer but are not taxed as income to the participants.  The majority owner can sell shares owned at least three years to the ESOP and elect to defer tax on the gain by reinvesting the proceeds in shares of domestic corporations no earlier than three months prior to the sale and no later than 12 months after the sale (Code §1042).  This qualified replacement property (QRP) can be an excellent subject for charitable contributions, providing deductions and capital gains avoidance.  The IRS also has approved transfers of QRP to charitable remainder trusts (Letter Rulings 9438012, 9438021).


Philanthropy and Special Needs Trusts

In general, a charitable remainder trust is permitted to pay the income interest to a noncharitable trust, but only if the trust is for a term of no more than 20 years [Reg. §§1.664-2(a)(5), 1.664-3(a)(5)].  However, the IRS has approved charitable remainder trusts that last for the life of a “financially disabled individual,” with payments made to a special needs trust (Revenue Ruling 2002-20).

The IRS indicated that such arrangements are appropriate where the income beneficiary, by reason of a medically determinable physical or mental impairment, is unable to manage his or her own financial affairs.  The trustee of the special needs trust could have broad discretion as to how much income or principal would be paid to the beneficiary, and could take into account government benefits to which the beneficiary may be entitled.

Assets in the special needs trust could pass at the beneficiary’s death either to charitable or family beneficiaries.  Proceeds from the charitable remainder trust would pass to the charitable remainder beneficiary.



Funding Considerations with Testamentary Charitable Remainder Trusts

In general, clients have greater flexibility in funding testamentary charitable remainder trusts than the lifetime variety.  Tangible personal property or ordinary income assets often result in diminished income tax charitable deductions if transferred to inter vivos unitrusts and annuity trusts.  No such reductions occur with respect to the estate tax charitable deduction.

Items of income in respect of a decedent — U.S. savings bonds, IRAs and installment sale notes — are arguably the best assets a testator can put into a testamentary charitable remainder trust.  In one private letter ruling, the IRS said there would be no immediate income tax on a charitable remainder trust funded with assets from an IRA (Letter Ruling 9237020).

Shares of stock, mutual funds and bonds that have increased in value make excellent assets to fund inter vivos charitable remainder trusts, particularly where the donor is the income beneficiary.  Trust assets are not depleted by capital gains tax when the trustee sells and reinvests the proceeds.  On the other hand, appreciated assets may be better left outright to family members, who receive a stepped-up basis equal to the date of death value. 


Retirement Remainder Trust

A client who wishes to provide retirement security for a personal nurse, housekeeper or other household employee may wish to consider a charitable remainder trust.  The trust is tax-exempt, like other retirement plans, with payments made for the life of the employee.  There are no complicated funding formulas or limitations on contributions.  A portion of the income interest may be subject to gift or estate tax, although the value could be completely sheltered by the $5.43 million applicable exclusion amount.  There would also be a charitable deduction for the value of the remainder interest.

A charitable gift annuity is also an option, although if arranged during the client’s lifetime, the gift annuity should be funded with cash, rather than appreciated securities, to avoid having the client subject to immediate capital gains tax on the value of the annuity interest.

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