The Absence of Symmetry (Part 2 of 2)

January 6, 2012
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As I mentioned in the first part of the series, the news is not all bad for those facing unwanted excise taxes.  A private foundation (PF) can avoid excise taxes if it owns less than 2% of the S corporation stock.  A charity may hold S corporation for five years if no more than 20% of stock is owned by the donor, his or her family and a PF and avoid excise taxes.  A PF may own unlimited amount of non-voting stock provided that disqualified persons, a defined tax term, own less than 20% of the voting stock.  There are many private rulings in the area that shape the contours.

I’d Like to Order a CLT Sandwich, Hold the ESBT Please

What does one do with a CLT after five years, or if the grantor dies during its term?  Most convert the trust to an ESBT, a less than welcome choice, for a charitable trust.  The ESBT’s 35% ordinary income tax rate applies but not to any capital gain. There is no charitable deduction for distributions to the charity that would reduce the 35% bite, but there is from the non-S portion of the trust [for example when it holds other assets.] Many advisors recommend that the S corporation give away an asset rather than suffer these rules upon the donor and a charity.  Charities prefer the sale of the asset to avoid UBIT.  Charities may not welcome the fact that S corporation income is UBIT, subject to tax, even if it arises from an activity that furthers a charitable purpose, whereas the same income in a LLC is not.   Distributions from a S corporation in excess of basis are capital gain. Losses may be limited by the passive loss rules and may not offset other income of the charity.  [Explain that result to the Board].  Low basis in S corporation stock may cause distributions to be taxable whereas LLC basis may have been higher due to the treatment of indebtedness. This is a another reason why a charity may be reluctant to accept S corporation stock.  If the donation of stock is the only option, the recipient should be a charitable trust rather a charitable corporation.