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.