How a Charitable Remainder Trust Can Help Charity and Save Income Taxes

As tax season rolls around, lots of us are thinking about ways we can reduce the income tax bite and with the downturn in the economy, it’s more important than ever to support charities in the work that they do. Business owners especially will often want to use their earnings to benefit the communities that supported them.

There is a way for business owners to donate to charity while also creating a sizeable retirement income for themselves and reducing their tax liability.  It’s called a Charitable Remainder Trust (CRT). When a business owner is ready to retire, she can gift either the entire business or her shares of stock to a Charitable Remainder Trust. Because the Charitable Remainder Trust is a non-taxable entity, it can then sell the stock or business without incurring capital gains taxes, which currently is 15 percent of the sale.

The tax savings would preserve principal to be reinvested in a diversified portfolio with the business owner named as income beneficiary and the charity of his or her choice named as remainder beneficiary. Thus, the business owner would receive an income for the term of the Charitable Remainder Trust and the charity would receive the assets at the end of the term of the Charitable Remainder Trust.  Let’s take a look at how this scenario would differ from an ordinary sale.

In a typical sale example, if a business owner sold his or her company for $10 million he would pay $1.5 million in capital gains taxes. The remaining $8.5 million could be invested and if we estimate an 8 percent annual return, the business owner would receive $680,000 before taxes. Assuming a 35 percent tax bracket, the business owner would be left with $442,000.

If the business owner instead transferred the business to a Charitable Remainder Trust and then sold it for $10 million the entire sales proceeds would be preserved for investment because the trust would not be liable for capital gains taxes. Assuming the same 8 percent return, the trust would generate a gross annual return of $800,000, 17.6 percent higher than the above example of a traditional sale.

The business owner can choose a distribution percentage of anywhere from 5 percent to 50 percent, but for the sake of this example, let’s say the business owner takes an 8 percent distribution receiving $800,000 with a final total of $520,000 after taxes, $78,000 more than the traditional sale example.

The business owner would benefit from a charitable income tax deduction in the year of the donation and up to five more years depending on different variables. Instead of paying sizeable capital gains taxes the business owner would only be liable for income taxes due on the amount received from the Charitable Remainder Trust.

In some cases, the company may choose to buy back and retire the majority owner’s stock making the remaining stockholders majority owners. Another option is to sell the stock to the individual stock holders.

One concern that business owners often have about Charitable Remainder Trusts is not having an inheritance to pass down to their children. But proper estate planning can rectify that situation by using the tax savings to buy a life insurance policy with the heirs named as beneficiaries.

If your client’s children have not followed them into the family business it would likely be much more difficult and burdensome for them to inherit the business. This is true not only because of the tax consequences but also because they might have trouble liquidating the assets.

Compared to a traditional sale a Charitable Remainder Trust can provide more income for the business owner, reduce his or her taxes and provide a way to leave a lasting legacy both to the owner’s heirs and the community.




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