BUSINESS OWNERS AND CHARITABLE GIVING

Patricia M. Annino '78

Bill and Melinda Gates, America's most generous donors, have given away over twenty three billion dollars, more than half of their net worth. The founders of Intel, the founders of Dell Computers, Ted Turner, New York Mayor Michael Bloomberg, Joan Kroc and Sanford Weill are all heavy givers too. Now you may say: "Easy for them. They can give away a fortune and still have more than enough not only to do whatever they want for their rest of their lives, but to be sure their children and grandchildren and great-grandchildren are protected as well."

That is true. It's also true, however, that you can own a family business, have much, much, much less than Bill and Melinda Gates, but still have enough in assets to have to pay estate taxes when you die. Would you rather voluntarily give that excess to Smith College, or involuntarily donate it to the Internal Revenue Service?  

Giving to reduce the amount of taxes you have to pay is, of course, only one reason to make a charitable gift. There are plenty of others. Women in particular, I find, want to be agents for change, and tend to be very creative in the way they zero in on a problem and use their money to solve it. Smith College, after all, was founded by a woman with a philanthropic vision.

Making a gift to Smith College now, during your lifetime, can help the college accomplish its goals, reduce your taxable estate, and, in some cases, enable you to earn an income tax deduction as well. Of course, before you make the gift, you should be sure that giving the asset away will not affect the way you live the rest of your life—that you do not, in fact, need that asset for yourself or for your family.

How do you go about making a gift using your business? There are many types of charitable giving vehicles to consider.  

An outright charitable gift is a direct gift to Smith College, and can be one that is tax motivated. Transferring a business asset that has greatly appreciated in value—or stock or real estate—to Smith College directly at the end of the calendar year could enable you to receive an immediate tax deduction for the value of the donated asset at the time you gift it, and also avoid paying a capital gains tax on the amount that the stock or real estate has appreciated. (Charitable gifts don't have to be financial assets. Some people give artwork, for example.)

If your business or the real estate that is affiliated with it is significant in value and has a hefty built in capital gain, it may be too significant an asset for you to give up completely. Instead of selling this asset outright (and paying a capital gains tax) or donating it outright to charity, you might want to consider first transferring it to an irrevocable trust, known as a charitable remainder trust. This enables you to retain income from the asset without having to pay a capital gains tax on its sale at the time of transfer. Once the asset is transferred to the trust, it is irrevocable, and you will never be able to get the principal back, but you, or you and your spouse, or your children (your choice which) can be the life beneficiaries. When the last of the persons specified as "beneficiaries" dies, the balance will be given to Smith College, according to directions you either issue now or include in your will.

When the trustee of the charitable remainder trust sells the business asset, since the ultimate beneficiary of the trust is a charity, there is no capital gains tax at the time of transfer, and that means the pay out to you from the investments is greater than it would have been if you had sold the asset, paid the tax on the gain, and invested the difference. If you can not afford to give up access to that principal, this type of technique is not for you. However, it works beautifully if there is a portion of your assets that you envision only being used during your lifetime for income.

Using a charitable remainder trust makes sense for someone who can afford to give up the business asset in trust, but wants the increased cash flow during her lifetime that would come from avoiding or delaying the capital gains tax and reinvesting some of the trust assets. Transferring the business, or the business real estate to the charitable remainder trust, and having the trustee sell the asset will accomplish those results. Clients of mine were three cousins who owned the family business. They decided it was time to sell the operating business—which had been in their family for many years—and decided to explore the possibility of transferring the stock to charitable remainder trusts to avoid the capital gain. Two of the three cousins did just that, but the third wanted to keep control of the principal and use it for future real estate deals, and did not go the way of the charitable trust.

In most states the family business owner can serve as Trustee of the charitable remainder trust. If the donor, donor's spouse or relative is acting as trustee of the charitable remainder trust, then an independent trustee or a qualified appraiser should be used to value the assets that are transferred to it . You should be aware that if the business is what is known as a Subchapter "S" corporation (that is a regular corporation that you have made an election with the Internal Revenue Service to treat as a flow through entity for income tax purposes), then transferring the stock to a charitable remainder trust terminates the "S" election, and since a corporation is not a natural person, any charitable remainder trust funded with corporate stock is limited to 20 years in duration.

A family who likes the idea of reducing the tax bill and having a current increased cash flow but is not too happy with irrevocably giving away the trust principal might consider coupling the charitable remainder trust with another type of trust—an irrevocable life insurance trust . This enables you to use part of the increased cash flow from the sale of the business to fund the payment of life insurance premiums that will replace the family wealth that will go away at the death of the last beneficiary of the charitable reminder trust. To remove the life insurance proceeds from the donor's taxable estate, the life insurance policy should be owned by an irrevocable life insurance trust. Coupling the charitable remainder trust with the irrevocable insurance trust should benefit the family business owner, Smith College and the family members as well.

Every client of mine who has decided to go this route has had charitable inclination and philanthropic intent. No one should ever decide to give away access to principal unless she is sure she will not need it, and no one should ever do so just to reduce taxes. (The tax tail should never wag the dog!) It is just one of the factors to consider when planning.

And then there are private charitable foundations, trusts or corporations established and funded entirely with the private assets or money of a wealthy family. This is a good technique for families who would rather have Smith College receive an annual sum than one significant gift.

The transfer of an asset to a private charitable foundation is irrevocable. In most cases after the asset is transferred to the foundation and sold, there are no capital gains taxes paid. The family has given that asset up. The current rules mandate that each year five percent of the value of the foundation's assets must be distributed to a combination of charitable organizations and administrative expenses. Family members serving as Trustees are entitled to reasonable compensation and benefits for taking on that responsibility. The M.S. Hershey Foundation that owns the controlling interest of Hershey chocolate is a private foundation. Milton Hershey and his wife did not have any children, and so, at his death (after hers), he placed his entire fortune (including his ownership interest in Hershey foods) into a private foundation whose mission was to support orphan boys. Because of that foundation, there is now a very good school in Hershey, Pennsylvania that educates orphan boys at no cost at all. Special programs at Smith College could be supported by this type of foundation.

Those with a significant net worth who wish to do more complicated estate planning can couple the charitable remainder trust with the private foundation so that when the charitable remainder trust ends (at the death of the last surviving income recipient or the term of the trust) the proceeds of the charitable remainder trust are then added to the family's charitable foundation.

Charitable gift annuities and deferred payment gift annuities are other appealing alternatives Smith College offers. Since the college administers them, the costs are borne by Smith, not by you. A charitable gift annuity gives you another flexible way to transfer an asset, significantly reduce your capital gain, and lock in a fixed rate for your lifetime (or the lifetime of a subsequent beneficiary, if you so desire). If, for example, you own stock worth ten thousand dollars that has a hefty capital gains tax built in and is not producing much income, you can transfer your stock to Smith College by a signed agreement. You will receive fixed payments determined by your age. The gift is irrevocable; you will never be able to receive the principal back and for that reason you will receive an income tax deduction. Also, part of your payments will be tax-free. That asset will, of course be removed from your gross estate and at your death the balance will go to Smith.

Strategies for Charitable Gifting:

1. For lifetime gifting, consider which of your assets have a current low income tax basis.

2. Consider whether you would like to unlock the value of those assets by transferring them now, avoiding or reducing the capital gains tax and converting them to an income flow for your lifetime. Be sure to take into consideration that you will be giving up the principal asset value during your lifetime. (And if you are reluctant to give up the ability to pass the principal asset value down a generation, then consider replacing that wealth through a life insurance policy owned in an irrevocable life insurance trust).

3. Think about whether Smith College should receive the assets at once or over a period of time.

4. Discuss the various charitable gifting strategies with your estate planning and tax advisors and with the planned giving office at Smith College.

5. Consider starting the gifting program now and making increased strategic charitable gifts to Smith College of more significance at your death, or if you are married when both of you die.

Patricia M. Annino '78 is Partner and Chair of the Estate Planning and Probate Practice Group at the Boston law firm of Prince, Lobel, Glovsky & Tye LLP. She received her law degree from Suffolk University, and earned an LL.M. in taxation from Boston University. With over 25 years of experience, she is a nationally recognized speaker and recently authored a new book, "Women & Money: A Practical Guide to Estate Planning," which explains, step by step and across many different living situations, how to determine your specific wants and needs in order to plan appropriately .