New Insurance Opportunities in Corporate Planned Giving, Part I (CC 06-09)

By: Gerald B. Treacy, Jr.

Introduction

A number of important new opportunities for life insurance sales are now opening in the developing realm of business planned giving. This new marketplace is expected to be many times as strong as the current marketplace for "wealth replacement policies" in the familiar area of individual planned giving. Most insurance planners are well aware of the opportunity for an insurance placement when an individual creates a charitable remainder trust. He or she is to receive the income from the trust for life (or a term of years), and thereafter the trust assets pass to charity, rather than to the children or grandchildren. This has long been recognized as an ideal opportunity for a life insurance solution: the "lost" amount, passing to charity, can be "made up" via a life insurance policy held in an irrevocable life insurance trust, or "wealth replacement trust."

What has not been realized, until recently, is that a "wealth replacement" market many times vaster than in the individual planned giving realm, exists—in corporate and business planned giving. While in theory the opportunity has existed since 1969 or earlier, it is only now finally poised to emerge as a major new product line opportunity. In fact, the neglect of this huge area has been so chronic, that the first book devoted to the tax treatment of corporate planned giving is due to be published this year by the author.[1]

Example: Insurance-Supported Charitable Sale of Corporate Asset: [2]

Before reviewing the legal foundations for corporate and business planned giving, let`s consider the following problem and solution.

Corporation A has been holding onto a highly appreciated parcel of land which it would long since have sold, but for its reluctance to incur the large tax liability which it would create for itself upon the sale. Corporation A`s cost basis in the land is $2,000,000, and the land is now valued at $50,000,000.

If Corporation A sold the land without utilizing a Charitable Asset Sale Trust, it would generate a tax liability of $16,800,000.

If instead, Corporation A utilizes such a Trust, it would incur no tax liability on the sale by the Trust of the land, translating into a savings of $16,800,000 for Corporation A.

Corporation A would also create a charitable income tax deduction for itself when it transfers the land to the Trust, based on the current value of the charitable interest in the Trust.

The Trust provides that, for 20 years, Corporation A will receive quarterly (or more frequent, if desired) distributions from the Trust. The Trust provides further that, at the end of the 20-year period, any remaining Trust assets which have not been distributed to Corporation A, will be distributed to Corporation A`s own Charitable Foundation, for use in creating community goodwill through charitable projects in the community, on behalf of Corporation A.

Corporation A uses a small portion of the overall tax savings to fund a $20,000,000 life insurance policy on one of its key executives, with the $20,000,000 in proceeds payable to Corporation A.

Among the key advantages for Corporation A are the following:

  • enormous savings on the sale of the asset;
  • creation of a charitable income tax deduction on the transfer of the asset to the Trust;
  • creation of a distribution stream for 20 years from the Trust;
  • ability to fund Corporation A`s Charitable Foundation with the later distribution of remaining Trust assets;
  • the Charitable Foundation can use the security of its future distribution to borrow on favorable terms, to permit it to begin immediately in performing charitable works on Corporation A`s behalf;
  • Corporation A will receive the life insurance proceeds as a corporate asset;
  • Corporation A will create community goodwill; and
  • Corporation A will secure favorable publicity for its transfer for future charitable use.

This business asset sale tool is by no means limited to publicly traded C corporations. It applies as well in the S Corporation context, and also to LLCs and partnerships. [3] In addition, as S Corps, LLCs, and partnerships are "passthrough" entities, the tax savings, as well as the charitable deduction, generated to the business passes through to the owners directly. The supporting life insurance could be secured by the business itself — the S corp, LLC, or partnership, which would handle it in a fashion similar to the C corp — or could instead be held directly by the business owners, via an irrevocable life insurance trust (or "wealth replacement trust") to avoid inclusion of any life insurance proceeds in the taxable estate of the owner.

Underlying Legal Principles

It appears that it took rather a long time for courts and legislatures to come to grips with the logical problems in recognizing that a nonhuman corporation could have "charitable intent." The earlier view, long since abandoned, was that corporations could not be charitable, and that any attempt by a philanthropic CEO or board of directors to make a corporate "charitable" gift was null and void, and the CEO and directors could be held liable to the corporate shareholders for this corporate "waste," as it was characterized. Over a relatively long period of time, a more practical view came to the fore: as a great deal of the national wealth was tied up in corporations, as the courts increasingly recognized, it was deemed more advantageous to encourage corporations to be philanthropic, despite the logical problems involved. At this point, of course, corporations and other business entities are actively encouraged by the law to make charitable gifts.

This encouragement is evidenced in the statutory provisions affording a charitable contribution deduction to a corporation or other business. C corporations are entitled to an income tax deduction for their charitable gifts, up to 10% of their taxable income, [4] with a 5-year carryover for any excess deductions which cannot be used in the first year. [5] As for S corporations, the shareholders themselves are entitled to the charitable deduction for contributions made by the entity, [6] as is also true of partnerships. [7]

Missed Opportunity

As well advised as many businesses have been in other strategic, legal and accounting realms, they seem to have "missed the boat" as to the significant opportunities afforded by planned giving techniques and the quite favorable IRS rulings in this area.

Businesses have tended to see charitable giving as something of a necessary but somewhat bothersome "aside" to the "real" work of making the business profitable. Businesses have tended to be quite limited in their charitable giving, when compared to individuals (including those who are themselves business owners, directors, and CEOs). Corporate giving is usually something of an "afterthought," rarely linked in any meaningful or synergistic way to the corporation`s main business of being profitable. In reality, that failure to link corporate philanthropy — and in particular corporate planned giving — with corporate "bottom line" profitability, has been dramatically expensive and wasteful to the business community, in terms of lost opportunities. With research materials now to be available to lawyers and accountants in the area of corporate planned giving, this oversight should be corrected rapidly.

Charitable Remainder Trusts

Most readers will be familiar with charitable remainder trusts in the context of individual planned giving. Little-known to businesses is the fact that the IRS has issued favorable rulings extending the use of charitable remainder trusts to corporations and other businesses. The IRS has ruled that C corporations, [8] S corporations, [9] limited liability companies ("LLCs"), [10] and partnerships [11] are all permitted to create charitable remainder trusts.

Charitable Lead Trusts

Another planned giving format, perhaps a bit less familiar than CRTs, are charitable lead trusts, or CLTs, which are sort of the "flip" version of CRTs. Instead of an individual receiving income for life or a term of years, followed by a distribution to charity, a CLT involves income distributions to charity for a term of years, followed by a distribution to one or more individuals. The IRS has ruled that corporations, [12] including S corporations, [13] are eligible to create CLTs.

Other Charitable Planned Giving Techniques for Businesses

A host of additional planned giving techniques have been approved for use by corporations and other businesses, including retained life estate gifts in real estate, historic easements, conservation easements, and pooled income funds, among others. All of these can be important in corporate philanthropic planning, and all of them can be enhanced via the use of life insurance.

Insurance-Backed Planned Giving Tools for Business Philanthropy

Here are several examples of tools developed by the author in which life insurance can enhance the favorable results for the business and charity alike.

Merger and Acquisition (M&A) Trust [14]

Mergers and acquisitions, as they are traditionally crafted, involve considerable negative consequences for the acquired or selling firm, and considerable expense for the acquiring or purchasing firm. The seller or its owners recognize ordinary income on the sale of its stock or assets, and the buyer`s offer must adequately compensate the seller and owners for these costs. Often these tax considerations torpedo otherwise viable mergers and acquisitions, and always drive up the purchase price even in successful M&As.

Using a Merger and Acquisition Trust, a merger or acquisition becomes dramatically more attractive for both buyer and seller. As early as feasible in the M&A process, ideally well before any contractual commitments are made, a prospective seller transfers its stock or assets (depending on whether a stock or asset sale is desired) to an M&A Trust. This can consist of all or any portion of the stock or assets. The Trust provides that seller is to receive a stream of distributions for a term of up to 20 years. At the end of the Trust term, whatever assets remaining in the Trust are to be distributed to the seller`s chosen charity, including the seller`s own charitable foundation. The seller is entitled to a charitable income tax deduction in the year it transfers the asset to the Trust, even though no transfer to charity will occur for 20 years. The trustee of the Trust then enters into negotiations with the prospective buyer for the sale of the stock or assets. When the sale has been consummated, the buyer owns the stock or assets, and the seller and its owners recognize no ordinary income or capital gain with regard to the Trust-held assets.

The seller can "make up" to itself or its owners the value of the Trust assets remaining at the end of 20 years, which are to be distributed to the seller`s selected charity. This "make up" is accomplished through a life insurance policy on one or more corporate executives or owners, with the insurance proceeds to be paid to the business. The premiums on this low-cost policy can be paid from the savings generated by the Trust creation and funding.

For example, assume that C Corporation A wants to make itself an attractive candidate for acquisition by another firm, and also wants to limit its expenses on a future acquisition. C Corporation A`s basis in the assets it wishes to sell is $5,000,000, and the current fair market value of these assets is $50,000,000. If C Corporation A`s stock were acquired in a traditional M&A, C Corporation A would realize ordinary income of $45,000,000, and would be liable for $15,750,000 in income taxes.

If instead, C Corporation A were to transfer the assets, prior to any negotiations with the prospective buyer, to an M&A Trust, and the Trust later sold the assets, neither the Trust nor C Corporation A would be liable for any ordinary income or capital gains tax on the transaction, yielding a savings of $15,750,000. The price to be paid for C Corporation A`s assets could profitably be considerably lower than in a traditional M&A, as there is no tax on the sale transaction, and in fact a tax benefit in the form of the charitable contribution is added. C Corporation A, or its successors or owners, would enjoy a distribution stream from the Trust for up to 20 years, and the charity C Corporation A names as the beneficiary of the Trust will then receive all remaining Trust assets.

Among the key advantages for C Corporation A in utilizing the M&A Trust are the following:

  • dramatic savings on the sale of the assets;
  • C Corporation A makes itself a far more attractive acquisition candidate;
  • charitable deduction on the transfer of the asset to the Trust;
  • creation of a distribution stream for 20 years from the Trust;
  • ability to fund the designated charity with the later distribution of remaining Trust assets; and
  • the charity can use the security of its future distribution to borrow on favorable terms, to permit it to begin immediately in performing charitable works for years to come.

M&A Trusts are also available to S corporations, LLCs, and partnerships, [15] and work equally well in these business contexts, where, once again, the savings and charitable deductions "pass through" directly to business owners.

Other Insurance-Supported Business Planned Giving Tools

Other insurance-supported business planned giving tools [16] have been developed to assist in the following business transactions and activities: providing for retirement compensation; providing for executive compensation; pre-planning for income-spike years and capital gains recognition years; and exit-planning for under-performing COLI and BOLI. Part 2 of this article continues in the April Current Comment.

Conclusion

A vast new opportunity for life insurance placement, one which greatly assists business bottom-line profitability, as well as freeing up vast amounts of new funds for charitable organizations, is in insurance-supported business planned giving.


[1] Treacy, "Charitable Giving and Business Entities," BNA Tax Management Portfolio (forthcoming in 2006).

[2] This example is based on the author`s patent pending tool. For licensing information, please contact the author at gbtreacy@aol.com.

[3] Patent pending by the author as to these tools, as well.

[4] Internal Revenue Code ("IRC") Section 170(b)(2).

[5] IRC Section 170(d)(A).

[6] IRC Section 1366(a)(1)(A).

[7] IRC Section 702(a)(4).

[8] See, e.g. , PLR 9205031 (November 5, 1991).

[9] See PLR 9340043 (July 8, 1993).

[10] See PLR 199952071 (September 23, 1999).

[11] See PLR 9419021 (February 10, 1994).

[12] PLR 7730005 (April 26, 1977).

[13] PLR 9512002 (September 29, 1994).

[14] Patent pending by the author; please contact the author at gbtreacy@aol.com for licensing information.

[15] These and other business planned giving tools are patent pending by the author; for licensing information please contact the author at gbtreacy@aol.com.

[16] These and other business planned giving tools are patent pending by the author; for licensing information please contact the author at gbtreacy@aol.com.

Copyright 2006, Gerald B. Treacy, Jr. All Rights Reserved.


Mr. Treacy has been serving affluent clients with their tax planning needs for over two decades, first as a partner at two of the nation`s largest law firms, Perkins Coie in Washington, and McGuire Woods Battle & Boothe in Virginia, and currently through his own law firm and as Of Counsel to Montgomery Purdue Blankinship & Austin, pllc, in Seattle. Mr. Treacy has authored three BNA Tax Management portfolios (on Supporting Organizations (2nd ed. 2002), Community Property (2005), and Charitable Giving and Business Entities (forthcoming in 2006)) and several other texts, as well as numerous articles on tax law, charitable giving, and estate planning, and speaks frequently on legal and tax planning topics nationally. He is the author of Washington Guardianship Law, Administration and Litigation, now in its 3rd edition (published by Lexis/Nexis). He has been quoted on the front page of the Wall Street Journal and in a number of other publications, co-hosted a television series on estate planning for a PBS affiliate, and is listed in Who`s Who in America and Who`s Who in the World. Mr. Treacy has been a Fellow of the American College of Trust and Estate Counsel (ACTEC) since 1993. Mr. Treacy has presented nearly 100 seminars on legal topics to attorney and CPA groups and others around the nation. He has been named a "Superlawyer" by Washington Law & Politics (2003, 2005).


Contact Info:

Gerald B. Treacy, Jr. - Law Office of Gerald B. Treacy, pllc - 19793 Hamilton Court NE - Poulsbo, WA 98370

Phone: 360.697.4142 - Fax: 360.697.3463 - Email: gbtreacy@aol.com


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