Reprint permission from the April 1996 issue of Crain's Small Business.
Among the super-rich, the charitable remainder trust is the most popular way of making a charitable gift contribution, while also getting a nice tax break.
But for many small business owners, that trust instrument is a largely unknown technique -- despite its potential for helping an owner or small business shareholder achieve his economic and philanthropic goals.
The business owner -- or anyone else owning a capital asset such as corporate stock or real estate which has grown in value -- contributes the asset to this special trust.
In doing so, two distinct tax benefits are immediately realized.
- First, the contribution isn't a "sale or exchange" in the eyes of the Internal Revenue Service. So, the "paper profit" on the donor's investment escapes capital-gains tax.
At the same time, the full amount of the assets is put to work toward the benefit of the donor's selected charity or a private foundation he might have created.
- Second, the full market value of the contributed asset, including any growth in its value, becomes eligible for a charitable deduction on the donor's income tax return.
If the deduction can't be fully used in the year of the gift, it can be carried forward for the next four years, sheltering the donor's future taxable income.
Obviously, even the most philanthropically minded business owner would be hard-pressed to give his business or any other significant assets away, no matter how attractive the tax benefits.
But, that's where the charitable remainder trust comes in handy.
The donor is only required to contribute to charity a "future interest" -- the value of the gifted asset or its proceeds after the donor dies.
In the meantime, the donor receives the trust's income, which may be generated by the asset that has been gifted or, if the trustee decides to sell that asset, by some other investment property. What's more, the donor isn't subject to a gift tax when he contributes stock or real estate to the trust.
And that property also escapes federal estate tax upon the donor's death. No longer does an owner need to fear a forced business sale to fund that estate tax.
The charitable remainder trust encourages a host of other planning possibilities.
Let's suppose the founder of a closely held company has seen the value of his stock holdings grow exponentially over the years.
But, for all kinds of good reasons, the company retains its earnings and pays low or no dividends.
However, the owner/shareholder wants to capture his company's payout value and is willing to forgo its future growth potential in favor of boosting his current income.
If he were to sell the company's stock and invest the proceeds in bonds or stocks that pay high dividends, he would first incur a capital-gains tax and thus put fewer dollars in his pocket.
But by contributing the company's shares to a charitable remainder trust instead, the owner is guaranteed a relatively high yield for life on the full value of the asset that he contributes.
The owner will successfully enjoy a tax-free switch from a dividend-poor growth stock to a higher-income-producing investment of equal value. And, even if the trust eventually sells the business, the owner will not pay a capital-gains tax on that sale.
Not surprisingly, the tax rules are tricky and the strategy isn't for everyone.
But for those who may wish to entertain planned charitable giving with a tax and economic edge, the charitable remainder trust may be worth investigating.
Marc J. Lane ([email protected]) is a Chicago lawyer and financial planner and an adjunct professor of law at Northwestern University School of Law.