Find out what types of assets make the best planned gifts. Learn about gifts of cash, securities and property.
Bob and Mary Are Giving Smarter and Achieving Their Dreams...Find Out How You Can Too!
Bob and Mary first met at Two-Bit Flicks, a 25-cent movie night held on Fridays in Brighton Lecture Hall. When the spring formal hosted by the women's dorm came around, Mary asked Bob to go with her. It was their first "official" date.
The rest, as the saying goes, is history. Or in Bob and Mary's case, it is natural history. That's because Emporia State also introduced them to a lifelong passion for the natural sciences.
Bob and Mary feel Emporia State was the catalyst for the life they've built together. Mary became a science educator for 6th, 7th, 8th and 9th grade students. Bob founded and served as director of the Great Plains Nature Center and became a renowned nature photographer.
Now they want others to have the same opportunity they did. They want to help students come to ESU and discover a passion they can follow for the rest of their lives.
Bob and Mary found a simple and easy way to achieve this dream. When they set up their trust, they named Emporia State as a beneficiary.
What's your dream?
Learn how easy it is to make your dream a reality by naming Emporia State University in your will or trust. Contact Angela Fullen, Director of Planned Giving at the Emporia State University Foundation. She can answer your questions or help you get started. If you have already named Emporia State in your will or trust, let us know. We will make sure your gift does everything you want it to do.
"I would encourage anyone, if they are thinking about doing something like this, to contact the Foundation. For us, it has been a great experience." - Mary Butel
Getting Started is Easy
Not sure how to take the first step? We've got just the thing you need. Download your free Will and Estate Planning Guide. This guide is an easy way to get started on, or update, your estate plan. It will help you explore your options at your own pace. It's free, easy and yours to keep.
Download your copy today or contact Angela Fullen to request a printed copy.
Article of the Month
C Corporation Business Sale
The sale of a business frequently occurs when the founders are approaching retirement age. Because the business is a major part of the estate and the founders may have spent most of their working years building the company, a sale of the business involves both emotional and financial issues. Frequently, the clients are so involved in the sale issues and have an emotional desire to see an appropriate continuation of the business that charitable planning is an afterthought. As was the case in Ferguson and Hoensheid, this circumstance can easily lead to "last-minute" decisions to make charitable gifts or fund a charitable remainder trust.
In Hoensheid, the Tax Court determined the taxpayer transferred stock to a donor advised fund (DAF) after the business sale was virtually certain and the gain had ripened. There was no bypass of capital gain on the gift and the taxpayer did not receive a charitable deduction because the appraisal and appraiser failed to meet the applicable requirements.
Similarly, for sales of small, closely-held corporations such as local banks, or for sales of mid-sized or even large public corporations, the natural proclivity is towards procrastination. Shareholders frequently do not want to make decisions until there is a clear sale and specified price. Because negotiations can be extended over months or even years, there is an understandable inclination towards delaying until the last minute before making charitable plans.
In Hoensheid, Scott Hoensheid indicated to attorney Andrea Kanski he was interested in creating a DAF with Fidelity Charitable. Ms. Kanski stated to Scott, "The deadline to assign the stock to a DAF is prior to execution of the definitive purchase agreement." Scott responded, "I would rather wait as long as possible to pull the trigger."
There are four specific time frames for this process. These include the negotiation period, the signing of the letter of intent, a vote to approve the sale by the board of directors and the shareholder vote.
Initial Negotiation Period
Quite often, the sale of a business will involve complex negotiations between the seller(s) and the buyer(s). During this initial phase, the parties might agree to the basic framework for how they will negotiate the specifics of the sale and how they intend to proceed with the sale. They might also agree upon an initial sales price or a range for the sales price subject to a business valuation process, a targeted closing date and a framework to negotiate the finer points of the sale including an agreement on various tax-related matters.
In Hoensheid, Commercial Steel Treating Corporation (CSTC) was founded by the grandfather of taxpayer Scott M. Hoensheid. In 2015, Scott and his brothers Craig and Kurt Hoensheid each owned one-third of CSTC. Kurt planned to retire and the three brothers decided to sell CSTC. They engaged the FINNEA Group as investment advisor and solicited bids. HCI Equity Partners (HCI) indicated it would be willing to purchase CSTC for $92 million. After further negotiations, all parties agreed on a sale price of $107 million.
Letter of Intent
The next step in the business sales process often involves the parties signing a letter of intent (LOI). The LOI reduces the parties' initial agreement to writing, describing the arrangement and includes an agreement to work together in good faith to consummate the sale of the business.
Letters of intent do not necessarily create a binding obligation to sell. As the Court in Rauenhorst noted, "[T]he letter of intent was not an offer; it was neither a purchase, tender, or exchange offer as the [anti-dilution] provision specifies." The Rauenhorst case noted that the LOI and the resolution accepting it "[did] not demonstrate that the warrant holders were legally bound, or could be compelled, to sell their stock warrants at the time of the assignments."
Therefore, with a typical LOI, there is a description of the proposed sale transaction, but neither party is legally bound to complete the agreement. Thus, there is no Rev. Rul. 78-197 binding agreement that precludes transfer of the stock to charity or to a charitable trust.
Negotiating the Purchase and Sales Agreement
The next step in the sale of an ongoing business is the negotiation of the Purchase and Sales Agreement. This negotiation process can be quite protracted. During this process, the parties will typically work to resolve a variety of issues. For example, what representations and warranties will the buyer require the seller to make concerning the business, its operation, cash flow and financials, receivables, financial liabilities, customer lists, on-going contractual obligations, potential liabilities and potential labor issues.
Even after the parties have signed a purchase agreement, the buyer will engage in due diligence and the closing for the sale will likely be contingent upon buyer's satisfaction that the seller's representations truly and accurately reflect the condition of the business. Even if the buyer has greater comfort about the condition of the business operation, following due diligence, the parties might also negotiate a process to resolve any issue that arises if a representation or warranty proves untrue post-closing.
Other issues that the parties may negotiate during this process include the buyer's ability to obtain adequate financing to complete the acquisition, the assumption of certain financial liabilities by the buyer and its principals and whether banks and other companies will agree to release the seller from personal liability. For example, if the corporation has an outstanding loan that the sellers have personally guaranteed, the buyer and sellers may want the buyer to assume the debt and the sellers will want the bank to release the sellers from their guaranty. In addition, the sale of certain businesses may be subject to regulatory rules or even require regulatory approval before the sales transaction can close.
In addition, the buyers and sellers will typically negotiate over the tax treatment of the sale. The buyer and seller may want to divide the sales price between the price for the stock purchase, create an agreement by the seller(s) to serve as a consultant, employee or director of the purchasing corporation and assign a portion of the sales price as consideration for the seller(s) signing a non-compete agreement.
The sales process is often complicated and the negotiation period typically involves various contingencies such as buyer waiving a due diligence contingency, financing contingencies and regulatory approval contingencies. If there is not yet a binding agreement during the negotiation period, under the guidance established by Rev. Rul. 78-197 outright charitable gifts or transfers to a charitable trust are generally permissible. Even if the founders have recently taken a family business public and have stock subject to transfer restrictions, it normally is permissible to transfer that stock to a charity or charitable remainder unitrust. With restricted stock, the charity or trustee of the unitrust may need to wait the applicable period of time before actually selling the stock.
Board of Directors' Vote
The process involving the sale of corporate stock may involve a vote by the Board of Directors of the selling corporation and, if the buyer is another corporation, by the buyer's Board of Directors as well. Typically, the vote of seller's board does not create a binding obligation to sell.
Under applicable state law, the sale of a corporation normally will not be completed without a positive vote by over 50% of the shareholders. However, if the directors own over 50% of the shares, the IRS may take the position that the vote by the board of directors is equivalent to a vote by over 50% of the shareholders and that there is a binding agreement.
In Ferguson, the donors suggested that until the final closing, the shareholders could have withdrawn their favorable vote and the sale might not have been concluded. However, the Court called this possibility "remote and hypothetical and therefore irrelevant."
Similarly, if over 50% of the stock is owned by the directors and these directors vote in favor of the sale, the probability the sale will not go through likely will be "remote and hypothetical and therefore irrelevant." In the circumstance where the directors approve the sale and own over 50% of the stock, the vote by the shareholders is a mere formality. It is probable that the IRS and the Tax Court would conclude that the obligation is now effectively binding and that the sale is subject to the standard of Rev. Rul. 78-197.
Under both Ferguson and Rauenhorst, the standard is quite clear. When over 50% of the shareholders have voted in favor of the sale, the gain has "ripened." There is value in this bright-line standard. So long as the charitable gift can be documented before the gain has ripened, the capital gain bypass will be successful. The best documentation is actual transfer of the shares on the corporation books as occurred in Rauenhorst prior to the final sale. Alternatively, if over 50% of the shares have been tendered in favor of the sale, it is doubtful that the capital gain bypass can be accomplished.
In Hoensheid, on June 11, 2015, CSTC held a shareholders meeting and the three brothers approved the "ratification of the sale of all outstanding stock of Commercial Steel Treating Corporation to HCI." They also accepted the request of Scott to transfer part of his stock to Fidelity Charitable. Scott had a partially prepared certificate but had not yet finalized the number of shares. The brothers agreed that CSTC would also "sweep the cash from the company prior to closing and distribute it to the brothers."
Scott Hoensheid testified at trial that the intent to make a gift of 1,380 shares existed at the June 11 stockholders meeting. However, the documents that established this number did not exist until July 9 or July 10. Therefore, there was no actual or constructive delivery prior to July 11 or July 12. There was a July 13 email and PDF of the stock certificate sent from Scott's financial advisor to Fidelity Charitable. The Tax Court determined that based on this strong documentary evidence, the actual date for the gift and acceptance of the 1,380 shares by Fidelity Charitable was July 13, 2015.
Assignment of Income
Under general tax principles, income is taxed to the person who earns it. For example, in Helvering v. Horst, 311 U.S. 112 (1940), the Court noted that income is taxed "to those who earn or otherwise create the right to receive it and enjoy the benefit of it when paid." A charitable contribution of an appreciated asset will bypass the gain if there is no prearranged sale, creating an assignment of income. However, the donor must transfer title prior to the ripening of the gain. The right to avoid taxation is available if there is no vested or fixed right to receive income at the time of the transfer. It is possible a gift transfer does not obligate the nonprofit to sell. In Dickinson, an individual made multiple share transfers to Fidelity Charitable and the shares were subsequently redeemed by the corporation. Because the redemption "was not a fait accompli at the time of the gift," the taxpayer was not subject to the "practically certain to occur" realization event. This principle was also relevant in Rauenhorst. Rauenhorst stated that while the courts are not subject to Rev. Rul. 78–197, the Commissioner is precluded from arguing against the IRS position on prearranged sales.
In Ferguson, the shareholders had approved the sale and the gain had ripened, but in Rauenhorst there still was uncertainty as to the sale and the gain had not ripened. The key issues in prearranged sale cases are whether there is a legal obligation to sell by the donee, actions have already been taken by the parties to effect the transaction and the remaining unresolved transactional contingencies.
In Hoensheid, Fidelity Charitable signed a Letter of Understanding expressly disclaiming an obligation to sell. However, actions taken by CSTC Directors had caused the transaction to be virtually certain by the July 13 gift date. Because the cash in the company of $6.1 million was distributed to employees through bonuses on July 10 and CSTC had decided to make the distribution of $4.8 million to the three brothers, the decision was essentially made to sell CSTC. The Tax Court noted, "We consider it highly improbable that petitioner and his two brothers would have emptied CSTC of its working capital if the transaction had even a small risk of not consummating."
Therefore, the transaction was virtually certain when the 1,380 shares were gifted on July 13. The final issue was an unresolved sale contingency for environmental liability. On July 13, the other issues had been resolved and the sale in the words of Scott was now "99% sure." Therefore, there were no significant unresolved contingencies. Because the sale was a virtual certainty, the gain had ripened and there was no bypass of gain on the gift of stock to Fidelity Charitable.
Unitrust Control Solution Avoids Prearranged Sale
Business owners prefer to retain control as long as possible. Their attorneys and CPAs would like to avoid a prearranged sale but face a major problem. In Hoensheid, attorney Andrea Kanski stated to Scott, "the deadline to assign the stock to a donor advised fund is prior to execution of the definitive purchase agreement." Scott responded, "I would rather wait as long as possible to pull the trigger."
A convenient solution to meet the objectives of the business owner and the professional advisors is to transfer part of the C Corporation stock into a two-life charitable remainder unitrust (CRT) with an advisor as trustee. A charitable remainder unitrust is a tax-exempt irrevocable trust that is funded by a donor and makes income payments to a noncharitable beneficiary. After all payments have been made, the remaining trust assets are transferred to one or more qualified exempt charities. It is best to minimize the prearranged sale risk by not selecting the donor as trustee. The donor has a good relationship with the advisor and the CRT may be created well before the final sale agreement. The donor retains the right to designate the Sec. 501(c)(3) nonprofit to receive the remainder. The buyer purchases stock from both the owner and the CRT. The sale is closed with control and no risk of prearranged sale.
After one or two years, the owner gifts the unitrust to the selected nonprofit and reports a deduction for the value of the income interest. Reg. 1.170A-7(a)(2)(i). If the CRT were immediately gifted to the nonprofit, the IRS may claim step transaction and disregard the CRT, but the delay for one or two years avoids this issue. This plan requires two qualified appraisals – one for the CRT remainder in the year the CRT is funded and a second appraisal for the year the CRT income interest is gifted to charity. Sec. 170(f)(11)(E)(ii). The qualified appraiser must fulfill the requirements in Notice 2006-96; 2006-46 IRB 1. Sec. 664(e) states the value of the income interest is based on the stated payout percentage, even if there is a FLIP or net income unitrust.
The transfer of the income interest also will qualify for a gift tax deduction. Reg. 25.2522(c)-3(c). Because a CRT is generally subject to the prohibition on excess business holdings, it has a five-year grace period to dispose of the stock. Sec. 4943(c)(6). The IRS may extend the disposal period by five years for certain large and complex holdings. Sec. 4943(c)(7).
Charitable deductions of appreciated assets are limited to 30% of a donors adjusted gross income (AGI). If the taxpayer is unable to deduct the full value of the charitable contribution in the year of the gift, he or she is able to carry forward the deduction for an additional five years. There is an added tax advantage with the CRT plan because the charitable deduction may be spread over more than six years. Some donors have delayed the CRT income interest gift for five years and deducted both gifts over ten years.
As founders near retirement age, the sale of a business may be an attractive exit strategy. Professional advisors should be mindful of the prearranged sale and assignment of income rules to prevent an adverse outcome for their clients. If a ripening of the gain has occurred, the taxpayer will not enjoy the bypass of gain benefit from a charitable contribution. Hoensheid provided an excellent case study related to the ripening of gain. Professional advisors should be mindful of timing when planning charitable gifts of Subchapter C corporation stock in the midst of a business sale.