Suppose Owner has a favorite charity he would like to benefit as part of his ownership succession and estate plan. Continuing with the prior fact pattern, instead of holding all of his QRP until death, Owner contributes $2,000,000 of his QRP to a charitable remainder trust (CRT), which allows him to take an income tax deduction for the value of the gift without giving up future income on the QRP. Establishing the CRT as a charitable remainder unitrust (CRUT) provides Owner with an annual payment from the CRUT, which is a fixed percentage of the annual fair market value of the CRUT’s assets. Generally, § 1042(e)(1) of the Code provides that Owner’s gift of his QRP to the CRUT is a “disposition” that triggers a recapture of the gain with respect to the $2,000,000 of QRP. However, the Internal Revenue Service has issued a series of Private Letter Rulings in which it takes the position that if the CRUT complies with the Code and other guidance issued by the Internal Revenue Service, then Owner will not realize any gain on his transfer of QRP to the CRUT. Owner receives an income tax deduction in the amount of the present value of the remainder interest, which passes to Owner’s favorite charity at the end of the unitrust term.
Another option for Owner is to contribute ABC stock directly to the CRUT, and then have the trust sell the stock to the ABC ESOP. Owner receives an income tax deduction for the value of the gift and avoids recognizing gain on the sale of the stock by the CRUT to the ESOP. The charity will invest the ESOP sales proceeds, and pay Owner an income on the investment proceeds until sometime in the future, at which point the charity may use the amount of the principal investment. This charitable planning technique is useful if Owner does not want to worry about satisfying the reinvestment requirements of § 1042 of the Code. § 409(n) of the Code contains a prohibited allocation rule which says that family members of a selling shareholder who elects to take advantage of the tax deferral under § 1042 of the Code cannot receive allocations of stock from the ESOP. Therefore, this technique is useful if Owner has family members at ABC and he wants to benefit them through the ESOP.
A final, as well as the simplest, charitable planning opportunity is for Owner to contribute all or a portion of his ABC stock directly to a charitable organization, which allows Owner to take an income tax deduction for the appraised value of his stock, after factoring any applicable minority interest discounts. The charity can then sell the stock that Owner contributed to the ABC ESOP.
It should be noted that charitable organizations described in § 501(c)(3) of the Code and exempt from tax under § 501(a) of the Code are qualified S corporation shareholders. However, a charitable remainder trust does not qualify. A charitable lead trust may qualify if it is a grantor trust for income tax purposes.