When you have a highly appreciated asset, like a closely held business, selling it generally comes with some intense tax consequences. Selling your interest in the company can result in significant capital gains. Imagine if you started your business with $50,000 and 20 years down the road, you sell it for $2.4 million. You’d be recognizing a $2,350,000 long-term capital gain. If you liquidated the business assets, depending on the business’s structure, the business might be taxed on the capital gains and then any distributions you receive would also be taxed.
The only way to avoid paying capital gains is to give your assets to charity; however, you didn’t get into business just to give it away. You likely invested in your company to make money and provide a lifetime income stream.
So how do you profit from your business, minimize your capital gains, and benefit a charity? One option would be to create a charitable trust. Generally, there are two types of charitable trusts: lead trusts and remainder trusts. In a lead trust, a charity receives the income generated and the remainder goes to your heirs. In a remainder trust, you receive the income stream and the remainder goes to the charity upon your passing.
Potentially, this can save you a great deal of money, as once you put the business or other highly appreciated asset in the trust, the trust can sell the asset and not incur any capital gains. Furthermore, this nets you an income tax deduction the year you move the asset into the charitable trust. The computation for the tax deduction is complicated, but it is generally based on the amount of income received, the type and value of the asset, the ages of the people receiving the income, and the Section 7520 rate, which fluctuates. If you cannot use the full deduction in the first year, you can carry it forward for up to five additional years.
Let’s say, for example, you put your $2.4 million business into a charitable remainder trust. You, as the grantor, can take an immediate tax deduction that year. The trust then sells the business and invests the profits, ideally continuing to grow the value. When setting up the trust, you can choose between a Charitable Remainder Annuity Trust, which provides you a fixed income payment, or a Charitable Remainder Unitrust, which provides an annual payout based on a percentage of the fair market value of the trust’s assets, calculated yearly. You can receive payouts from a charitable remainder trust for life or for a period of time, up to 20 years.
Payouts from the trust are generally taxed at long-term capital gains, but now you’ve spread the tax over several years. When you pass away, the balance of the trust goes to a charity, which is tax exempt.
You can further control how the assets are donated if you make the beneficiary of the trust a Donor Advised Fund. The benefit of a Donor Advised Fund is that your charitable gifts are not tied to one specific charity. Because the donor recommends which charities grants are distributed to, your heirs can be named as successor donors and can direct your charitable contributions after you are gone, creating a family legacy.
Overall, charitable remainder trusts are ideal for taking highly appreciated assets and developing an income stream for you while reducing your taxable estate, and providing a current tax deduction and creating a charitable legacy for your family.
If you have questions on whether a charitable trust would work for your situation, the experts at Henssler Financial will be glad to help:
- Experts Request Form
- Email: experts@henssler.com
- Phone: 770-429-9166.
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