Business Exit Planning Using Charitable Strategies
Business owners usually have four goals when they leave their businesses: retire from the business; sell to a new owner (family members, employees, or third parties); minimize taxes and maximize profits. For those who are already charitably inclined, business exit planning using charitable tools allows them to add a fifth goal: doing good things for their favorite charity or their community.
In this issue, we continue our series on business exit planning by examining some frequently used charitable planning tools and some common pitfalls.
Tools for Business Exit Planning Involving Charitable Giving
Three tools involving charities are typically used in business exit planning: charitable remainder trusts, gift annuities and charitable lead trusts.
A charitable remainder trust (CRT) is a tax-exempt trust. It is primarily an income tax planning tool with some estate and gift tax benefits. With a CRT, the appreciation in assets can be realized without immediate gain recognition tax-free, a stream of payments created for the donor and a deferred benefit provided to a charity. An income tax deduction, gift tax deduction or estate tax deduction is based on the remainder value that passes or is projected to pass to charity at the end of the trust term. Certain private foundation rules apply, which can be problematic.
A gift annuity is essentially a bargain sale in which the consideration paid by the charity is in the form of annuity payments. Code Section 72 specifies how the income is categorized; i.e., how much is return of principal and how much is ordinary income. Code Section 1011 specifies how gains are recognized, for example if the gift annuity is funded by contribution of appreciated assets. Code Section 415 limits payments to one or two persons. Private foundation rules do not apply to gift annuities.
A charitable lead trust (CLT) is the opposite of a charitable remainder trust in that the income stream is paid to charity with the remainder going to private individuals. A CLT is primarily an estate or gift tax tool. If it is set up as a grantor trust, it can also provide some income tax benefits. Unlike a CRT, a CLT is not a tax-exempt trust. Some private foundation rules apply to CLTs.
What If You Already Have a Business Entity?
When we are involved in the original business planning and choice of entity, our engagement often involves an initial Risk Assessment of the areas of risk that your business will most likely be subject to. These risks can involve business processes, record keeping, reporting, compliance procedures, economic and capital structure, labor structure, procedures and compensation, insurance coverage, and a number of other issues. The purpose of this Risk Assessment is to attempt to anticipate risk exposure and assist in providing structure, processes and safeguards to eliminate, minimize, or prepare for such risks.
If we have not participated in the original planning, were not asked to initially conduct that review, or after any business has been operating for a while, we offer a Business Review and Audit Package which includes a Risk Assessment. This process allows us “audit” and assess the choice of entity, whether conditions have changed, and the common risk areas and exposure brought about by the way the business is operating. We offer several Review Packages priced to accommodate the needs of any business.
The Business Review Process parallels the steps of the Entity Choice and Formation Process. In general the necessary information is gathered, reviewed and evaluated and a report presenting our findings, along with recommendations for changes, a timeline and the price of our services to design and implement the recommended changes.
Gathering the Information about the Business and Your Goals
In order for us to review and assess your situation, it will be necessary for us to get a very clear picture of how your business is operating. We will do that through interviews, gathering documents and observation as well as discussions with you and your other advisors after we have been engaged. We actually begin that process during our initial contact before you have engaged us where we gain a basic understanding of your business and concerns. We will explain our business planning process and schedule a time for you to meet with our attorneys and often your other key advisors.
We will send you our Confidential Business Information packet which includes: