Most successful business owners have spent years building their business into a profitable enterprise. However, as retirement approaches they are often discouraged to find that selling their business will have serious tax consequences, hindering their ability to achieve their economic and family goals with so few after-tax dollars.
One way to reduce the “diminishing effect” taxes can have on your future lifestyle is to utilize a Charitable Remainder Trust (CRT) as part of your estate plan. CRT’s offer business owners an immediate income tax deduction as well as the ability to reduce or eliminate estate and capital gains taxes, all while creating retirement income, a meaningful gift for charity and an inheritance for your children.
A CRT is an irrevocable trust where income is paid to trust beneficiaries for a term of years or for life, with the remaining assets going to charity. Since a CRT is a tax-exempt entity the trust is not subject to tax. So if a business is transferred to a CRT, which then sells the stock, no capital gains tax will be paid, leaving a larger sum for re-investment and payout to trust beneficiaries. This is in contrast to wen an owner sells a business directly to a third party, often triggering capital gains tax on all the appreciated value they have created. In addition, the donor(s) receive a charitable deduction when the asset is transferred to the trust.
At retirement, the business owner, who is also the CRT beneficiary, will receive annual payments from the trust for life. Since this interest is a life annuity, there will be no estate inclusion at death, thereby greatly reducing or eliminating estate taxes. The CRT assets ultimately pass to a charity of their choice.
This is great news for the business owner and the charity, but what about the kids? Life Insurance can offer an excellent solution in maintaining a legacy for your heirs. In this case, some or all of the tax savings and increased cash flow gained by the use of a CRT can be used to purchase insurance in an irrevocable life insurance trust (ILIT) for the children’s benefit. The life insurance in the trust is structured to help replace the value of the asset gifted to the charity. If the ILIT is properly drafted, designed, and funded, the death benefits will pass free of estate and income taxes.