Exiting the Business in a Meaningful Way

Portrait of a smiling shop owner standing in his shop

When planning for a future exit, most business owners aim to find the most income tax-efficient way to sell their business. The sale of a business can result in a huge capital gain, but there is a way to reduce taxes, benefit from an income stream, and provide for charitable causes. If you have clients who are business owners and have long-term charitable intentions, a Charitable Remainder Trust can be a strategic solution to accomplish financial and philanthropic goals. Charitable Remainder Trusts provide a tax efficient way to structure the sale of a business while also benefiting one or more charitable organizations that are dear to the business owner.

How a Charitable Remainder Trust Works

A Charitable Remainder Trust (CRT) is established by an individual (the Grantor) for their own benefit or for the benefit of one or more persons and provides such beneficiaries with a lifetime income stream. Prior to the sale of a business, the owner may transfer all or a portion of the equity interest into the CRT. Upon the death of the Grantor or the last-named income beneficiary, any remaining assets in the CRT are then distributed to one or more charitable organizations. CRTs are especially attractive because the Grantor retains the flexibility to change these charitable beneficiaries during their lifetime.

The income provided to the beneficiary, known as the "income interest," can take two forms: either a fixed dollar amount per year or a percentage of the assets of the CRT, recalculated annually. Regardless of the chosen method, the income interest must be at least five percent (5%) of the initial contributed assets' value or their annual valuation.

When the income interest is a fixed dollar amount, the trust is called a Charitable Remainder Annuity Trust (CRAT). The CRAT offers the advantage of a guaranteed payment, irrespective of the trust's investment performance, however the beneficiary does not benefit from any appreciation in the trust assets during their lifetime.

Alternatively, when the income interest is based on a fixed percentage of the asset value, the trust is known as a Charitable Remainder Unitrust (CRUT). Here, the trust assets are evaluated annually to determine the payment to the beneficiary, allowing such beneficiary to benefit from any increase in asset value. Oftentimes a business owner may prefer a CRUT over a CRAT if they expect that the business interests, when sold by the CRUT, will sell for a multiple of the value that was donated to the CRUT. Additionally, unlike the CRAT, a CRUT permits additional contributions after its initial funding by the Grantor.

Benefits of a Charitable Remainder Trust

  • Immediate Income Tax Deduction on Creation of CRT: When a Charitable Remainder Trust (CRT) is established, the Grantor is donating a future interest in the assets to charitable organizations. This act allows the Grantor to claim a current income tax deduction equal to the estimated present value of that future charitable gift. The deduction is calculated based on a formula provided by the Internal Revenue Service and is subject to the limitations otherwise imposed on charitable deductions during a given year.

  • Deferral of Income Taxes Upon Sale of Business: As the CRT is a charitable entity, when the business interests held by the CRT are sold, no income tax is due upon such sale. As a result, the CRT is able to invest the sale proceeds, including the amounts that would otherwise be subject to income taxes were they to be sold by an individual, and such investments grow income tax free.

  • Income Stream to Beneficiaries: During the lifetime of the income beneficiaries, the CRT will provide distributions to such beneficiaries, which provides them with liquidity. While these distributions are subject to income taxes, the deferral of income taxes inside the CRT (as discussed above), generally allow for returns that are greater than if the assets had been invested on a post-tax basis, which in turn, provides a greater income stream to beneficiaries.

  • Exclusion from Taxable Estate: Because the assets inside of the CRT pass to a charitable organization, they do not increase the Grantor’s estate tax obligation should the Grantor have a taxable estate upon the Grantor’s death.

Selling a Business with Purpose

Clients who own businesses have a unique philanthropic opportunity that can allow them to sell their business with purpose and impact, with the potential of benefiting from tax advantages and a dependable income stream. By leveraging a Charitable Remainder Trust, business owners can donate their business interests and bypass immediate capital gains taxes while simultaneously making a meaningful impact on the causes they care about.

About the Author

Samuel M. DiPietroSamuel M. DiPietro
Associate, SpencerFane

Samuel collaborates with families and their advisors to create customized estate plans that consider the specific needs of each family, ensuring the protection and seamless transfer of wealth. Samuel, a certified public accountant with two advanced degrees in taxation, has successfully implemented plans that reduce income, gift, estate, and generation-skipping transfer taxes in the context of succession planning for individuals and privately held businesses.