Business Exit Planning Using Charitable Strategies


Volume 3 • Issue 7 • August 2013

The Counselor is a monthly newsletter of Hallock & Hallock dedicated to providing useful information on estate planning, business succession planning and charitable planning issues.  This month’s issue is the fourth in a series on charitable planning opportunities.  In this month's issue, we will look at the use of charitable strategies in business exit planning.  If you are interested in learning more about the ideas discussed in this newsletter please contact us for a free initial consultation.

Business owners generally have two over-arching goals when exiting their business - maximize profit and minimize taxes. The charitable planning tools discussed over the last few issues of this newsletter can provide a means to meet those goals while at the same time assisting a favorite charity. The most common charitable planning tools used in business exit planning are the charitable remainder trust, charitable lead trust and charitable gift annuity. The following is a brief review of each of the strategies.

Charitable Remainder Trusts

The charitable remainder trust (CRT) is a tax-exempt trust that permits a business owner to:

  • Increase the income potential from a highly appreciated asset by delaying the impact of capital gains taxes on sale;

  • Obtain an immediate income tax deduction based upon an IRS formula;

  • Reduce estate taxes as a result of the gift to charity; and

  • Benefit a charitable organization.

A CRT works by transferring appreciated assets into an appropriately designed irrevocable trust. This removes the asset from your estate thereby reducing the size of your estate for estate tax purposes. You also receive an immediate charitable income tax deduction.  The trustee of the CRT can then sell the appreciated asset at full market value, paying no capital gains tax on the sale.  This allows the entire sale proceeds to be re-invested into an income-producing asset.  The CRT then pays an income stream for a specified term (up to 20 years) or for the rest of your life.  The amount of the income stream is determined by you subject to certain limitations imposed by law.   At the end of the specified term the remaining trust assets go to the charity or charities you have chosen.  If you are concerned that the value of the asset will no longer be available to transfer to your children, consider using the income tax savings and part of the income you receive from the CRT to fund an irrevocable life insurance trust (ILIT). The trustee of the ILIT can then purchase life insurance to replace the value of the asset for your children or other beneficiaries.  Certain private foundation rules apply.

Charitable Lead Trusts

In theory, a charitable lead trust (CLT) can be thought of as the inverse of a charitable remainder trust in that the income stream is paid to charity with the remainder going to private individuals.  In reality, the rules governing CLTs can be quite different.  A CLT permits an owner to:

  • Shelter property from federal gift and estate taxes while passing ownership to family members.

  • When established as a grantor lead trust, produce an immediate federal income tax deduction for the present value of the charity's interest

  • Avoid federal estate and gift taxes to the donor on the appreciation in the value of the property between the date of the gift and the date of death.

A CLT is primarily an estate or gift tax tool and unlike a CRT, a CLT is not a tax-exempt trust. Some private foundation rules apply to CLTs.

Charitable Gift Annuity

A charitable gift annuity is generally a transaction in which an individual transfers cash or other property to a charitable organization in exchange for a promise from the charity to make a fixed annuity payment to one or two life annuitants. The Internal Revenue Code specifies how the income is categorized; i.e., how much is return of principal and how much is ordinary income. The Code further specifies how gains are recognized, for example if the gift annuity is funded by contribution of appreciated assets. Private foundation rules do not apply to charitable gift annuities.

Business Succession Traps

When using these charitable planning tools to facilitate business exit planning, there are several potential traps.  These traps include the transaction being deemed a prearranged sale, the unrelated business taxable income (UBTI) rules, and the rule against self-dealing.

Prearranged Sales

If the sale of the business or asset is arranged prior to the contribution of the asset, the IRS will treat the donation as part of a unified transaction. This is the prearranged sale rule. Violating the prearranged sale rule means the sale proceeds will be treated as income to the donor and the donor will not avoid recognition of capital gains on the sale.  The owner-donor can identify potential purchasers and even negotiate a price – but the charity or trustee of the trust must not be obligated to consummate the sale.

Unrelated Business Taxable Income (UBTI)

All tax-exempt organizations, including charitable trusts, are subject to tax on UBTI. With some exceptions, UBTI is income from a trade or business that is owned and regularly carried on by the charity or charitable trust, but is not substantially related to the tax-exempt functions of the charity or charitable trust.  Income from debt-financed property is always UBTI regardless of whether an exception would otherwise apply. Debt-financed property is any property held to produce income and with respect to which indebtedness was incurred when acquiring or improving the property.  With limited exceptions, a charity or charitable trust has acquisition indebtedness when it acquires property (by a gift or purchase) that is subject to debt or borrows against the property to make improvements.  The tax consequences for UBTI can be significant, especially for a CRT.


The Internal Revenue Code Section enumerates six specific acts of self-dealing for a private foundation:

  1. The sale, exchange or leasing of property between a disqualified person and the foundation;

  2. Loans of money or any other extension of credit between a disqualified person and the foundation;

  3. The furnishings of goods, services or facilities between a disqualified person and the foundation;

  4. The payment of compensation or reimbursement of expenses by the foundation to a disqualified person;

  5. The transfer of income or an asset from the foundation to a disqualified person for the disqualified person's use or benefit; and

  6. An agreement by the foundation to pay a government official, other than an agreement to employ the official for any period after the termination of his government service, if the official terminates his government service within a 90-day period.

Disqualified persons are defined by the Internal Revenue Code as the donor; the trustee; family members (which include the grantor's spouse, ancestors, children, grandchildren, great-grandchildren and the spouses of these individuals); and controlled business organizations.  The private foundation self-dealing rules are applicable to CRTs and CLTs, but not charitable gift annuities.   As a result, a charitable gift annuity rather than a CRT or CLT should be used in a transaction where the purchaser will be a disqualified person.


By incorporating charitable planning tools into the business exit plan, the owner has an excellent opportunity to maximize profits, minimize taxes and do some good.  If you as a business owner are charitably inclined, consider the possibility of using one of these tools as part of your exit plan.

This Newsletter is for informational purposes only and not for the purpose of providing legal advice. You should contact an attorney to obtain advice with respect to any particular issue or problem. Nothing herein creates an attorney-client relationship between Hallock & Hallock and the reader.