You have spent decades of your life building your business with blood, sweat, and tears. Now, you are looking to the future, and you are ready to sell for $5 million, $10 million, or more. But wherever there’s a massive windfall, the government always wants a piece.
Between federal long-term capital gains, state capital gains, and Net Investment Income Tax (NIIT), you could lose 40 to 60 percent immediately in taxes. You need a strategy that allows you to maximize your earnings potential, and a charitable remainder trust capital gains strategy is the key. Essentially, you are trading that tax liability for a 10% charitable gift at the very end of the plan, which could be more than fifty years out.
How can a charitable remainder trust play into your exit plan? Here is what you need to know to get more money out of the sale of your business.
How to Leverage a CRT in Your Business Sale
A charitable remainder trust is a powerful financial planning tool that enables you to minimize capital gains taxes from the sale of valuable assets, such as real estate or appreciated stock. Of course, this can also include your business.
Keep in mind one crucial caveat: You must execute this strategy before you sign your binding letter of intent (LOI).
Once you decide to move forward with a CRT, you transfer a portion (usually 20 to 100 percent) of your business stock into an irrevocable tax-exempt CRT. Then, the trustee (often you) sells the business to a buyer.
Because the charitable remainder trust is a tax-exempt entity, it incurs no capital gains tax on the sale. In other words, the trust retains 100 percent of the proceeds to reinvest in a new endeavor or portfolio. The trust then pays you an income stream for life or up to twenty years, or in some cases, both your life, then twenty years to a beneficiary or even multiple beneficiaries.
The Triple Tax Benefits of CRTs
You know that you want to maximize the sale of your business, but is a charitable remainder trust the right move? Since charitable remainder trusts have a lot of pros, you would be hard-pressed to find a more advantageous method of selling your business. CRTs have a triple-threat tax advantage.
Bypass Capital Gains
The first tax benefit is the one that draws in most business owners seeking a sale. By selling the business within the trust, you can preserve the full principal. The sale is not subject to any capital gains taxes, no matter how much you stand to earn.
The only catch is that those funds are not at your immediate disposal, but the preservation of capital may be worth it.
Immediate Income Tax Deduction
One of the benefits of a charitable remainder trust is that it permits you to engage in legacy giving as well as draw an income stream for life. At the conclusion of the trust, the remainder will go to the charity of your choice.
What does that mean when you make a contribution to the CRT?
Because a portion of the proceeds is going to a qualified charity, you gain a charitable deduction in the year of the transfer. Make a large enough contribution to your CRT, and you may have some serious tax benefits during the year you contribute, even beyond the reduction of capital gains.
Tax-Favored Income
The distributions you received from the trust are taxed under the tiered system, also known as a Worst In, First-Out (WIFO) method. But a large portion is often effectively taxed as capital gains over time rather than all at once. This makes it more palatable to those who need a little breathing room from the sale of major assets. This is also a very important reason to work with an advisor who understands the importance of maintaining the tax characterization of your trust assets.
Final Warning
Are you convinced that a charitable remainder trust is the right move for selling your company? It can be an appealing way to preserve the funds that you stand to earn and continue to reap the benefits of that sale for decades to come. However, you need to plan ahead.
This is the most critical part of this blog for your compliance.
You must abide by the rules if you want to leverage those triple tax benefits. If a sale is virtually certain or a binding agreement has already been signed before you fund the trust, the IRS will view your financially savvy move as a sham.
The consequence?
You will be taxed the same as if you sold it personally. That means you will be subject to significant penalties for capital gains taxes at both the state and federal levels, as well as NIIT. This will undo all of the hard work that you put into planning your business exit strategy.
This means you should start planning as early as possible. As soon as the thought that you may want to sell soon comes to mind, you should start forming your trust, because it takes time to establish the legal framework and transfer assets.
Never sign a Letter of Intent until the trust is fully funded to avoid the penalties you would be hit with from not executing the strategy the right way! The rules are ticky tacky and seem counterintuitive in some ways, but it is crucial that they are followed to the letter.
Magellan Sets You Up for Success
When you know that a charitable remainder trust makes the most sense for the sale of a business, don’t trust the formation to just anyone. Magellan offers comprehensive estate, financial, legal, and tax planning with the formation of your trust. We ensure that you do everything by the book to maximize the benefits of this strategy.
Give us a call today to learn more about how we can help you set up your charitable remainder trust so that it is ready when you are ready to move on.
For a comprehensive review of your personal situation, always consult with a tax or legal advisor. Neither Cetera Advisor Networks LLC nor any of its representatives may give legal or tax advice.
This material provided by Kevin Meaders was written by Axle Eight, a non-affiliate of Magellan Planning Group and Cetera Advisor Networks LLC.