Tuesday September 24, 2019
Case of the Week
Stock Unitrust Payouts to Donors
Case:Jim Thompson, a retired engineer, and his wife Janet Thompson, a retired nurse, are currently considering funding a term of years charitable remainder unitrust (CRUT) with their favorite charity. The charity is raising money to construct a new building to house a state-of-the-art theatre and museum.
The Thompsons are active investors and have amassed quite an investment portfolio over the years. In particular, they invested in a medical services company that has quadrupled in value. They would like to use $800,000 of their stock in this company with a cost basis of $100,000 to fund a five-year CRUT with a 15% payout. The Thompsons believe that this medical services company is a great investment with acceptable risk and would prefer that the trustee of the CRUT not sell the stock. Furthermore, the Thompsons would like their CRUT payouts to be the actual stock – an in-kind distribution – as opposed to cash payouts. Thinking creatively, the Thompsons wonder if such a distribution would avoid capital gain since, technically, the stock has never been sold.
Question:Can the Thompsons accomplish their goal of a tax-free 'in-kind' distribution of their stock? What are the tax consequences to the CRUT and the Thompsons of such a transaction?
Solution:Regulation 1.664-1(d)(5), which deals with distributions in-kind, states that the amount paid shall be considered as an amount realized by the trust from the sale of the property. With respect to the Thompsons, their basis in the stock will be its fair market value at the time it was paid to them. Therefore, in the first year, the trust will distribute $120,000 of stock (800,000x15%). The trust will realize $105,000 of the $120,000 as capital gain and $15,000 (100,000/800,000x120,000) as corpus. Under the four-tier accounting rules of Sec. 664(b), the Thompsons will report $105,000 of capital gain and the remaining $15,000 will not be taxable. Finally, the Thompson's new basis in the stock will be $120,000, which was its FMV at the time it was distributed.
With this plan, the Thompsons will receive a partly tax-free distribution. However, when taking into account their charitable income tax deduction of $370,000, income payments of more than $500,000 over the five-year term and a projected gift to their favorite charity in excess of $450,000, the Thompsons are very pleased with this arrangement. Because of their wonderful generosity, the Thompsons have the gratification of knowing they helped build a monument that will last a lifetime.