Perhaps you can identify with this story:
Joe Carpenter and his wife have worked long and hard to build their contracting business. With a very small investment of money and a very large investment of sweat equity, their business is now quite profitable and provides them with a healthy annual income. Their children have their own careers and no interest in working in the family business. The Carpenters would like to retire and enjoy life, and have found a qualified buyer willing to pay them a fair price.
Sounds like the American Dream, so what’s the problem? Taxes. The Carpenters will owe a substantial amount of capital gains tax if the business is sold outright. That means the cash they will have to invest will be reduced substantially — thus a lower income in retirement.
To add insult to injury, that’s not the end of the tax story. When Mr. and Mrs. Carpenter die, their assets will be subject to federal estate tax (up to 55 percent), as well as Pennsylvania inheritance tax (6 percent to lineal descendants, 15 percent to others). Their children will receive less than half of what they leave behind. Not quite what they had in mind while they were building the business all of these years.
So what’s the answer? The Carpenters might be able to solve their problem by giving their business to a charity.
“Hold on,” you say. “No one likes to pay taxes, but I’m sure not going to give my business away for free.”
Consider :
- The Carpenters could give their business to a qualified charity of their choice, receiving a significant income tax deduction.
- The charity (a tax-exempt organization) could then sell the business to the qualified buyer without paying capital gains tax.
- The charity could invest the proceeds and pay a guaranteed lifetime income to the Carpenters. At their deaths, the remaining asset belongs to the charity.
- If the Carpenters want to be sure that the value of their business gets passed on to their children, they could set up an irrevocable life insurance trust (ILIT) that is funded with a second-to-die policy. The death benefit of this policy would be based on the value of the business gifted. If set up properly, the proceeds would pass to the children estate tax free.
The Carpenters would have eliminated their capital gains tax, increased their income and avoided federal estate tax. Organizations such as The United Way and The Pittsburgh Foundation can help facilitate this type of arrangement if the charity of your choice is not set up to do so. A financial adviser or estate attorney can analyze the impact that charitable planning can have on your situation and help guide you through the details.
The Carpenters are destined to become philanthropists at their death no matter how you look at the situation. The question is whether they do it voluntarily as outlined above, or involuntarily, by funding social programs with their tax dollars.
Ruth Forsyth is a senior account manager and manager of market development with The Acacia Group. She co-hosts the “All Things Financial” radio programs Wednesday nights from 7 to 8 p.m. on KQV-AM (1410). Reach her at (412) 922-4360 or by e-mail at [email protected].