ESOPs Coupled With Charitable Remainder Trusts

Another transaction that is done from time to time by ESOP proponents counseling business owners is to couple an ESOP with a Charitable Remainder Trust (a CRT).   Appendix 4 shows you what can be accomplished under this arrangement.  Here a 65 year old man who owns a corporation worth $12,000,000 contributes 1/10th of its stock— which is, after a minority discount, worth $ 1,000,000—to a CRT and reserves a $50,000 dollar annuity (which is the approximate yield he was getting on that $1,000,000 worth of stock).  The CRT then, in turn, sells that stock to the corporation’s ESOP.  Here, the first line in this example shows the $1,000,000 worth of stock that is “invested” into the CRT.  (I use the word “invested” even though it is a charitable contribution—but, under the circumstances, you will see why I use the word “invested.”) Note that the stockholder who placed $1,000,000 into the CRT retained a $50,000 annuity from it, so he has retained a 5% yield.  But, when he contributed that stock to the CRT, he got an income tax deduction that saved him $168,000, leaving him with a net investment of $832,000.  Now his $50,000 annuity increases his after-tax benefit yield up to 6%.

Next, consider that he has also extracted $1,000,000 out of his taxable estate which reduces his estate tax by 35%.  But, I “present valued” that saving because he has a 21 year life expectancy, so the present value of the $350,000 of estate tax saving is $184,000.  Now, his “investment” in this transaction is down to $648,987, but he is still getting that $50,000 annuity and his yield is up to 7.7%.

But consider that when the company in which he now owns a 90% interest makes the $1,000,000 contribution to its ESOP that it uses to buy that stock from the CRT, it gets a deduction worth $400,000 (40% of $1,000,000), 90% of which ($360,000) inures to him.  If the company is an S corporation, that tax benefit flows right through to him, while as a C corporation it offsets what would otherwise be tax at the corporate level.  At this point, his “investment” has been reduced to a mere $288,000, but since he is still getting that $50,000 a year annuity, his yield is now up to 17.7%.  To me this is intriguing.  He is making a charitable contribution but increasing his yield on his original contribution from 5% up to 17.7% as a result of it.

Changing the facts a bit, assume that this fellow is married and the $50,000 annuity is joint and survivor, so that when the last of the two dies a charity gets the corpus of the trust and their heirs lose what might otherwise have been a portion of their inheritance.  Under those circumstances, I suggest that the donor and his spouse set up an irrevocable life insurance trust to buy a last-to-die life insurance policy on their joint lives sufficient to restore the lost inheritance for the children at the time when the last of the two dies.

Now let’s assess what has been accomplished.  When all is said and done the donor/investor will have benefited a charity, got his name “up in the lights” and basked in the notoriety of being a major contributor to, say, his university.  And, in the meantime, the couple will be receiving a handsome yield on their money and, as I see it, the whole transaction makes great sense and is made possible only because an ESOP is involved.

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