Business Funding Secrets
Business Funding Secrets

Business Deals and
Capital Gains Tax
 

Almost everything you own and use for personal, or business, purposes is a capital asset. When you sell a capital asset, the difference between the amounts you sell it for and the amount you paid for it (the basis), is a capital gain or a capital loss. Capital gains may also refer to "investment income" that arises in relation to real assets, such as property, financial assets, and intangible assets such as goodwill. Many countries impose a tax on capital gains of individuals or corporations. In the U.S. all capital gains must be reported.

 

There are high expectations that taxes on capital gains will be increasing in the U.S. When, and how much, the taxes increase will have an enormous impact on many business transactions due to the considerable tax liability.

 

During this period of history where it is more difficult to finance a business transaction, business owners may be required to lower their asking price, so a buyer can qualify for the financing required. However, this is a dilemma for the seller who wants as much money out of the deal as possible. For some sellers their business is the largest asset they will ever own and selling the business at a certain price has been part of their retirement and estate planning for many years. The perception that they have to cut out a larger chunk of the proceeds to give to the government will cause some business owners to change their plans. There are financial tools and strategies that allow the perception to be shifted. One strategy that is currently available to assist the capital gains tax burden is the Charitable Remainder Trust (CRT).

 

CRT’s are legally described as, Split Interest Trusts. The term is used because of the blend of philanthropic motivations and personal financial aspects. CRT’s can decrease tax liabilities, increase a business owner financial wealth, and at the same time provide a vehicle for charitable giving.

 

CRT’s are formed when a person donates assets to this special type of Trust. Assets can be cash, stocks, real estate, etc. The CRT is set up for a set period of time, or until the donor’s (business owners) death. An individual (business owner) can receive income from the Trust’s assets. Upon the donor’s death the assets go to a designated charity. Part of the income from the Trust can be used to purchase life insurance on the donor. The proceeds of the life insurance go to a designated heir(s) who receive the money without incurring any estate tax liability.

 



CRT’s are a tax-planning tool that also provides benefits to charity. Nationwide professional financial planners are using CRT’s to maximize their clients’ financial position, and at the same time increasing charitable donations.

 

Third party appraisals or business valuations must be completed to determine the asset or business value. For the charitable deduction, the donated value will be limited to the cost basis of the asset and not the current fair market value. CRT’s, as a concept, are very simple to understand. However, strict and complex tax rules govern how and when a CRT can be set up.

 

As a tool for reducing capital gain taxes, CRT’s are often used when a business, or other highly appreciated asset, is going to be sold. In accordance to the IRS codes, assets must be transferred to the CRT before there is any obligation to sale the asset. Since CRT’s are irrevocable trusts, the assets cannot be taken back out of the CRT once donated. An owner of an asset, whose sole purpose it to attempt to reduce capital gain taxes on the sale of an asset, must be warned that if after the transfer of the asset to the CRT, and the sale of the asset does not happen for any reason, the asset cannot be returned. Strict, complex, and specific procedures must be followed in order to take advantage of the CRT benefits. Only someone who has advanced knowledge in these matters should be retained to guide the donor through the process of setting up a CRT.

 

To qualify as a CRT the trust must meet all the requirements set forth in the Internal Revenue Code 664, and must, from its creation, in every respect meet the definition of, and function exclusively as a CRT. The requirements cannot be met unless each transfer to the trust qualifies in itself as a charitable deduction under the Internal Revenue Codes.



 

There are issues that may affect the status of the assets ability to be donated to a CRT. Non-qualifying assets may reverse the benefits of the CRT causing the CRT to lose its tax-exempt status.

 

When the CRT ends at its designated time period, or with the death of the donor, the remaining assets in the Trust will pass to the charitable organization. The designated charity can be any legally formed tax-exempt organization including a family foundation.

 

Family Foundations are tax exempt/nonprofit organizations, which provide tax advantages and control over philanthropic activities. Family foundations are typically private foundations that are funded by a small number of sources, and do not conduct widespread fund-raising activities. They may receive gifts from friends and limited sources.

 

Family members serve as trustees, directors, and officers. As private foundations they can make grants, or donations to other organizations. Having a Family Foundation provides a number of benefits including, income tax deductions, exemptions from estate and gift taxes, along with the reduction or elimination of other taxes.

 

As tax rates increase more business owners will use tools such as the CRT to legally put more money in their pocket instead of the governments. Business owners selling a large asset, or their company, typically use the money to invest in other assets whether it is new equipment or real estate, business or personal.

Some tax strategies including the use of CRTs are not widely known. It would be advisable for business owners and consultants to be aware of the different tools that are available in structuring a business transaction. They should also be aware that only a professional with vast experience in CRTs should be used to setup a Charitable Remainder Trust. Not following the strict IRS guidelines could be cause for increased taxes, penalties, and in some cases criminal charges.

Over the years there has been unscrupulous individuals who have tried using CRTs and similar financial tools in illegal scams. With the increase in capital gains taxes there are expectations more scams will be floating around out there. Be knowledgeable and be aware.

 

 

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