Creative Charitable Strategies for Clients with Sub-Chapter S Shares

Bryan Clontz, CFP®President, Charitable Solutions, LLCBryan@charitablesolutionsllc.com

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 incomeException – 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

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

Taxation – Trust vs. Corporate Rates

UBIT Solution:Dechomai Asset Trust Donation Flow

Step 3 –Dechomai Asset TrustGrants Net Proceeds to DAF at American Endowment Foundation (AEF)

Step 2 – Dechomai Asset Trust Sells Shares

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

UBIT at trust rates ($800K @ 15%) = $120K in tax

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 StudyInvestment Advisor Selling to Jr. Partner

Public Charitable TrustWith a Donor Advised Fund

Sells to New Partner/15% GainsTax Reduced by 50%

for Deduction

Donor Receives a 100% FMV Deduction.Donor’s DAF at AEF Receives Net 93%

of Gift as GrantVs. Sale and Gift of ProceedsNetting 77% to DAF at AEF.

Donor Contributes S-Corp to Trust-Form

Public Charity in Nevada (Income Tax-Free State)

Joe SmithJoe Smith

Sells 80 shares

BuyerBuyer

Dechomai Asset TrustDechomai Asset Trust

Smith DAF with AEF

Smith DAF with AEF

Cash

Sells 20 shares

Cash

Cash

UBIT Deduction

Donates 20 shares

Income Tax Deduction

Charity A Charity B Charity C

Grants

Grant recommendations

  1 2 3 4

 

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

Client Givesto a Private Foundation

Total Donor Tax Savings Less Taxes Paid 600,000 2,000,000 2,000,000 0

Total Amount Left for Charitable Giving 4,000,000 4,475,000 3,425,000 3,425,000

4 Scenario Summary

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

Scenarios

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