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Saturday September 23, 2017

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 with their favorite charity. The charity is raising money for the construction of a new building to house a state-of-the-art theatre and museum. The Thompsons are active investors and have amassed quite a portfolio over the past few years. In particular, they have investments in a medical services company that has quadrupled in value. They would like to use $800,000 of stock with a cost basis of $100,000 to fund a five-year charitable remainder unitrust (CRUT) with a 15% quarterly payout. However, they believe this company is a great investment with acceptable risk and prefer that the trustee of the CRUT not sell this 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 tax on the 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:

Reg. 1.664-1(d)(5), which deals with in-kind distributions, 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 the stock's fair market value (FMV) at the time it was paid to them. Therefore, the trust has an amount transferred of $120,000 ($800,000 x 15%) in its first year. The trustee will realize $105,000 of the $120,000 as capital gain and $15,000 ($100,000/$800,000 x 120,000) 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 Thompsons' new basis in the stock will be $120,000, which was the stock's FMV at the time it was distributed.

Under this plan, the Thompsons receive a partly tax-free distribution. However, when taking into account their income tax deduction of $370,000, income of more than $500,000 over the five-year term and the 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.

Published August 25, 2017
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