Creative Charitable Strategies for Clients with Sub-Chapter S Shares

Bryan Clontz, CFP® President, Charitable Solutions, LLC [email protected]

404-375-5496

Agenda

• • • • • • •

UBIT Definition and Overview UBIT Exceptions UBIT and S-Corp Stock: A Summary UBIT Solution: Dechomai Asset Trust Trust Rates vs. Corporate Rates UBIT Case Studies UBIT Resources/Articles

UBIT Definition and Overview

•Code Section 512 defines UBIT as income derived from an unrelated trade or business – UBIT has existed for nearly 60 years •Tax is paid at either corporate or trust rates •Charities must file 990-T and publicly disclose UBIT section •IRS may audit UBIT compliance/accuracy •Practical applications and compliance of UBIT are particularly complex •UBIT typically arise with S-Corp stock, real estate with debt or real estate with active service income •Some charities automatically decline UBIT gifts

UBIT Exceptions

Passive Income – rents, interest, gains, dividends, royalties, etc.

1. Exception – debt financed income Exception – mortgage for 5 years and owned for 5 years “old and cold” 2. Exception – S corporation income Charitable Remainder Trusts are not exempt from UBIT, charitable gift annuity contracts are exempt under acquisition indebtedness rules IRC 514(c)5 but the funding asset is not exempt

UBIT and S-Corp Stock: A Summary

•There are more than 3 million S-corporations - about the same as C-corporations and LLCs combined – with nearly 6 million shareholders •In 1998, Congress allowed charities to be qualified shareholders of S-corporations but not CRTs •Charities would have to pay UBIT on passive income as well as any pre- and post-contribution gain •Donor receives a fair market value deduction (less any ordinary income reduction) on stock

Taxation – Trust vs. Corporate Rates

Trust Rates

(basically the same as individual rates) •15-35% with the top bracket hit at $10,450 •Capital gains are taxed at 15%

Corporate Rates

•15-39% but are constructed to average 34-35% •Capital gains are income •First bracket at 15% is up to $50K, last bracket is 35% over $18.33M in taxable income

UBIT Solution: Dechomai Asset Trust Donation Flow

Step 1 – California Donor Contributes S-Corp Stock to Dechomai Asset Trust, A Nevada Public Charity Deduction: $1M of S-corp stock with $200K adjusted basis Step 2 – Dechomai Asset Trust Sells Shares UBIT at trust rates ($800K @ 15%) = $120K in tax Step 3 –Dechomai Asset Trust Grants Net Proceeds to DAF at American Endowment Foundation (AEF) Trust receives a 50% of AGI deduction to reduce tax to $60K plus $25,000 charitable fee or $85K net with $915K to charity; If donor sold asset, gift/deduction would have been $800K (25% tax federal and state)

Case Study Investment Advisor Selling to Jr. Partner

Donor Contributes S-Corp to Trust-Form Public Charity in Nevada (Income Tax-Free State) Public Charitable Trust With a Donor Advised Fund Sells to New Partner/15% Gains Tax Reduced by 50% for Deduction Donor Receives a 100% FMV Deduction.

Donor’s DAF at AEF Receives Net 93% of Gift as Grant Vs. Sale and Gift of Proceeds Netting 77% to DAF at AEF.

Joe Smith Grant recommendations Sells 80 shares Cash Donates 20 shares Cash Income Tax Deduction Buyer Sells 20 shares Cash Smith DAF with AEF Grants UBIT Deduction Charity A Charity B Charity C Dechomai Asset Trust

4 Scenario Summary Scenarios 1 2 3 Client Sells Shares, Then Gives Proceeds to AEF Client Gives Shares to DAT, Then DAT Grants Net Proceeds to AEF Client Gives Directly to a Corporate Form Public Charity 4 Client Gives to a Private Foundation

600,000 2,000,000 2,000,000 0 Total Donor Tax Savings Less Taxes Paid Total Amount Left for Charitable Giving 4,000,000

Assumptions: S-Corp Shares FMV Cost Basis $5,000,000 -0 Federal Tax (Ordinary Income) 35% Federal Tax Rate (Capital gains) 15% State Income Tax 5%

4,475,000 3,425,000 3,425,000

UBIT Resources and Articles

•American Endowment Foundation Tools: Flow Chart and Worksheet •

The Tax Law of Unrelated Business for Nonprofit Organizations

by Bruce Hopkins, John Wiley & Sons (2005).

•“Tax Savings Opportunities for Charities Owning Subchapter S Stock,” by Laura Peebles – Planned Giving Design Center •“UBTI in Charitable Planning” – 2008 ACGA Conference by David Wheeler Newman •“Gifts from Subchapter S Corporations and Their Shareholders,” by Chris Hoyt and Pam Segars – 2006 NCPG Conference