Thursday December 7, 2023
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 an arts charity. The charity is raising money for the construction of a new building which would 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 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 for the duration of the trust. 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 then wonder if such a distribution would avoid 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 medical services stock? What are the tax consequences to the CRUT and to the Thompsons of such a transaction?
Solution:Internal Revenue Code Regulation Section 1.664-1(d)(5), which deals with distributions in-kind, 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 its fair market value (FMV) at the time it was paid to them as a trust payout. Therefore, the trust has an amount transferred of $120,000 (800,000 x 15%) in its first year. The trustee will report for tax purposes $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 Section 664(b), the Thompsons will report $105,000 of capital gain and the remaining $15,000 will not be taxable as it is a return of basis. Finally, the Thompsons' new basis in the stock will be $120,000, which was its 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, over $500,000 of projected income over the five-year term, and an estimated gift to 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 home to the arts that will last a lifetime.