Charitable Planning for Business Owners in Transition. Two Examples: CRT & DAF

Wednesday, November 28, 2018 |

When it comes time for business owners to transition their ownership, they face a multitude of choices to convert their equity into a lifetime stream of income for themselves and their families. This can also present an excellent opportunity for a charitably inclined individual to utilize a 501(c)(3) entity of their choice in a tax efficient manner. Below are two of the most common strategies:

Charitable Remainder Trust (CRT) - A CRT can convert a highly appreciated asset -- closely held stock, real estate, etc.-- into lifetime income in an income and estate tax efficient manner. It averts capital gains tax when the asset is sold, provides a significant current charitable income tax deduction, and income for the lifetime of the seller, seller's spouse, and even other heirs while satisfying charitable objectives by leaving the remainder of the Trust assets to one or multiple charities. Because no capital gains tax is paid upon the sale, the seller has significantly more principal on which to produce income.

  • How a CRT works – The seller transfers an appreciated asset into an Irrevocable Trust and receives an immediate charitable income tax deduction. The seller and/or their heirs can be Trustee and can sell the highly appreciated asset and avoid capital gains taxes on the sale because of the charitable nature of the Trust. The deduction is calculated by subtracting the value of the income interest over the lifetime(s) of the beneficiaries from the total value of the asset, using IRS tables for life expectancy.
    • The CRT then provides a stream of income for the lifetime(s) of the seller, seller’s spouse, and even the seller’s children; however, the longer the CRT pays income the lower the current charitable income tax deduction.
    • Once the last of the income beneficiaries of the CRT pass away, the remaining balance of the Trust is payable to the designated charity(s).
    • There must be a Minimum Remainder Interest (MRI) of at least 10% left in the CRT when the income stream ends.
  • Rule to keep in mind
    • Prearranged Sales – Simply put, if the seller is too far down the road on a transaction – letter of intent, written agreement, even binding oral contract - they risk the IRS challenging the charitable deduction.

Donor-Advised Fund (DAF) - A DAF allows an individual to contribute cash or appreciated securities to an account. The individual then surrenders ownership of the assets transferred into the DAF. The individual can direct the DAF to contribute to any 501(c)(3) charity at any time. In the case of an anticipated sale of a business asset, a DAF can prove to be a powerful tool in securing tax savings, turning it into charitable good.

  • Contributions can be made in a lump-sum or an on-going basis, i.e. annual contributions of appreciated stock leading up to a business sale.
    • Often, when a business is sold, the owner has the highest income year of their life. A lump-sum contribution to a DAF can help to lessen the tax impact of that high-income year if the owner is charitably inclined.
  • The assets of the DAF must be used for charitable purposes: the individual does not receive any form of income from the DAF.


Note: This is an oversimplified example and much more analysis is required to determine appropriateness and tax effects.

None of the information in this document should be considered as tax advice. You should consult your tax advisor for information concerning your individual situation.