ELITE ADVISOR BEST PRACTICES

Why Charitable Gifts of Noncash Assets Should Matter to Elite Advisors - Part One

Some of your clients are charitable.

By Phil Cubeta

Key Takeaways:

  • Successful business owners seldom hold much in cash. The bulk of their assets are, generally, tied up in the business, or in real estate.
  • Charities almost always ask for cash. After cash, they seek public assets—assets you manage.
  • The win/win is to have clients donate noncash assets as part of an overall plan for wealth transfer and business exit.
  • In the process, by using the right charitable tools, you can bring your AUM up—way up.
True story

Todd came to our wealth transfer firm the day after he sold his business, a C corporation with zero basis, for $100 million. His capital gain was 20 percent. Tax due was $20 million. He said, “God gave me this money, and if I don’t give some back, he will take it all back. Help me wipe out my $20 million tax bill.” We helped him some, but the truth is he came to us at least one day too late.

Tools you might consider for business transfer

Private foundation? No.

You and your client initially may think that a private foundation is the right charitable tool to use in transferring a business. This is a mistake. Private foundations are subject to “the private foundation rules,” expressly enacted by Congress to prevent foundations from holding family-owned businesses. The easy way to remember this is: “Family firms and family foundations do not mix.” For those who violate the rules by cramming a family firm into a family foundation, the tax penalties can be stiff. They start at 10 percent of the amount involved and rise to 200 percent if not quickly corrected. Further, the deduction for anything other than cash or publicly traded stock is limited to the owner’s tax basis in the property. In Todd’s case, had he given $100 million in appreciated private stock to a foundation, his deduction would have been zero.

CRT? Sometimes yes.

As you know, a Charitable Remainder Trust (CRT) allows a donor to gift cash or property and get an income tax deduction for the remainder interest that goes to charity at the end of the trust term. The trustee can sell an appreciated asset inside the trust without the trust or the donor paying tax on the sale. The donor can get an income back from the trust, set as a dollar amount or percentage of assets given. In a Charitable Remainder Annuity Trust (CRAT), the dollar amount is fixed at inception. It cannot be less than 5 percent of assets given. And it does not go up or down. It locks in. A Charitable Remainder Unit Trust’s (CRUT) payout, in contrast, goes up and down as trust assets increase or shrink. So, if the trust pays 5 percent, the dollar amount in a CRUT will vary as the trust assets rise or fall.

CRT gotchas
  1. Debt-Encumbered Property. “Phil,” the call came from an advisor, “can you help me? I had my client give his land with debt on it to the CRT. Now his CPA says he has taxable income.” The issue? When property gifted to charity or a charitable tool has a loan against it, the donor has a taxable event. The loan amount is considered cash received and is taxed as a bargain sale. (The basis in the property is allocated across the part deemed given and the part deemed sold, and the donor’s share of the gain is treated as capital gain.) Moral: Pay off any debt on the property prior to gifting.

  2. Buyer Waiting in the Wings. “Hi, Phil,” went the call. “Help! I had my client put his business into a CRT. He sold it the next day—$10 million of capital gain. Now, under audit, my client owes tax on that.” The issue is “prearranged sale.” Since this was, effectively, a done deal with a buyer prior to transfer, the IRS treats the transaction as though the sale were made prior to transfer. How close to a sale is too close? That is for the tax attorney to opine on. Moral: Always ask whether there is a buyer waiting in the wings. If there is, slow things down while you get the tax attorney involved.

  3. Delayed Sale of an Illiquid Asset. The call went like this: “Hi, Phil, can you help me? I did a CRAT three years ago, funded with land. I just got a call from the trustee. Seems we never made a payout.” The problem here is that the trust, under its terms, must make a payout at least once a year, and there is no cash inside the trust to do that since the land has not been sold yet. Moral: For a gift of illiquid assets, consider an appropriate trust design, such as the Flip-CRUT. When a Flip-CRUT is used, the trust does not owe a payout until a specified triggering event occurs. A suitable triggering event could be the sale of the property.

  4. Unrelated Business Taxable Income (UBTI). The call went like this: “Phil, this can’t be right. My client’s CPA says the trust income is taxable. All I did was put my client’s business in there.” The issue here is UBTI. If the property given produces income that’s unrelated to the charity’s mission, then that flows through to the owners—and as with, for example, an S corporation, the trust will be taxed on that income. The gain upon sale, too, is taxed to the trust. Also, if it is an S corporation, the S election will be revoked. Moral: Be sure to ask about the business form early; get the tax attorney involved to determine the implications.

In Part Two of this article, we’ll discuss the pros and cons of donor-advised funds and show how you can help your clients with their charitable intentions—and still get paid.


About the Author

Phil Cubeta, CLU, ChFC, MSFS, CAP is the Wallace Chair in Philanthropy at The American College and is responsible for the Chartered Advisor in Philanthropy (CAP®) designation. Prior to joining the American College, Phil was Chief of Staff for The Nautilus Group, a service of New York Life, providing estate, business, and philanthropic strategies to affluent clients of its member agents.

To learn more, consider The American College’s Chartered Advisor in Philanthropy designation, CAP®. Click here or call Mary Anne Roselle at 610-526-1395.