The Prearranged "Stock Holder" Sale
Ken Barker, 65, was a senior level manager for a highly successful mid-sized company. After 35 years of employment with the same company, Ken retired three months ago. Fortunately, Ken planned and saved wisely for his retirement. Accordingly, Ken's retirement accounts have grown to almost $2 million. Ken, therefore, can now spend his weekdays fishing, golfing, spending time with his wife and grandchildren with little financial worry. In addition, Ken volunteers at a local mission.
Soon after his retirement, Ken received another financial surprise. During his 35 years of employment, Ken purchased a small amount of company stock each year. The value of the stock each year was quite nominal, so Ken did not pay much attention to it. However, last week Ken's company sent him a letter regarding the purchase of Ken's company stock for a jaw-dropping $500,000. Ken, of course, is ecstatic over the growth of his company stock. However, Ken realizes he will have to report nearly $500,000 in capital gains this year when he sells the company his stock because his basis is very low. Ken wants to avoid this result if possible and spoke with his attorney Sari Timmons regarding his options.
Sari recommended a charitable remainder unitrust as a possible solution. The CRUT would bypass the capital gains tax on the sale of the company stock and generate a sizeable charitable income tax deduction. In addition, the CRUT would pay income to Ken and his wife for their lifetimes. At the end of the trust, the local mission would receive the remaining trust corpus. Ken loved the idea and wanted to implement the plan. However, Sari obtained a copy of the company's stockholder agreement and now has some reservations.
The stockholder's agreement reads: On the death, retirement, dismissal, disability or resignation of any of the Stockholders, all shares then owned by such Stockholder shall be sold to and purchased by the Company. The value of the shares will be fixed by resolution of the Board of Directors.
Can Ken transfer his stock into a CRUT and achieve his objectives? Are Sari's reservations valid? What are the obstacles to this plan?
In order to preserve the bypass of capital gain benefit, a donor must avoid a transaction that would be deemed a prearranged sale by the Service. In other words, property must be transferred to the charity with no legally binding obligation in existence. While there can be prospective buyers, there cannot be any signed or oral binding agreement to sell. If there is a binding agreement, then the capital gain will not be avoided even though it is transferred into a CRUT. This rule also applies to CGAs and outright gifts of property.
In this instance, Ken is bound by the Stockholder's Agreement with his company. Specifically, at his retirement, Ken's requirement to sell and the company's obligation to buy became effective. Moreover, the price was fixed and predetermined. Thus, the trustee of the CRUT appears to have no freedom to select a buyer or set a price for Ken's company stock. Consequently, even if Ken transferred the stock into a CRUT, the capital gain may be reportable in the current year pursuant to the Ferguson case. Accordingly, Sari is wisely informing Ken of the potential risk associated with a transfer of Ken's company stock. Therefore, Sari's concerns regarding the prearranged sale were valid.
Instead, Sari suggested creating a deferred charitable gift annuity for Ken and his wife with other appreciated assets. This would still produce a sizeable charitable income tax deduction that could be used to offset part of the capital gains tax due. Making the most of the situation, Ken happily chose to fund a two-life $200,000 flexible deferred charitable gift annuity and used the $106,000 charitable income tax deduction to offset his tax liability this year. Ken then quickly turned back to more pressing activities like fishing, golfing, and spending time with his wife and grandchildren - with little financial worry.