Bills / Cases / IRS

QUESTION - Step Transaction: Will the Gift of LLC units to a charity and then repurchased by the donor be treated by the Service as a step transaction?

ANSWER: Under Palmer v. Commissioner, 62 T.C. 684, 691 (1974), Affd. 523 F.2d 1308 (8th Cir. 1975), taxpayers have, on many occasions, made gifts to charity with subsequent repurchases or redemptions. So long as there is not a legally binding obligation, this process has been regularly permitted.
To make a gift and repurchase less vulnerable, it is essential that there be no written obligation to repurchase. In addition, perhaps 4-8 weeks should pass between the gift and the repurchase. If the transaction involves a very substantial property, then it may be appropriate to obtain a Private Letter Ruling before the reacquisition of assets.


QUESTION - DAF and Self-Dealing: Why may a donor repurchase assets that have been given to a Donor Advised Fund?

ANSWER: In essence, the gift of assets is directly to the charity for the benefit of the Donor Advised Fund. Thus, the public charity actually owns the assets. Since a public charity is not bound by the Section 4941 self - dealing rules, a public charity may sell assets back in an arms-length fair market value sale to a donor. In addition, so long as the note bears a reasonable interest rate, an installment sale would also be permissible.


QUESTION - S Corporation and Subsidiary LLC: Will there be gain recognized to the S corporation when assets are transferred in exchange for LLC units?

ANSWER: An S corporation is taxed as a partnership under federal law. Thus, as is true with other partnerships, the Subchapter S corporation may transfer assets to the LLC and receive LLC units in exchange. This is not a taxable transaction, but the cost basis of the assets will flow through to the units. Thus, the units may be gifted to charity or may be sold. If sold, there would be capital gain recognition upon the sale of the units.


QUESTION - DAF and Trustee or Director: After creating a Donor Advised Fund (DAF), may the donor also serve as a director or trustee of the charity?

ANSWER: Since the public charity is not bound by the Section 4941 self-dealing rules, it is permissible for a donor to serve as a director or trustee of a public charity, even if he or she has created a DAF. As a matter of good judgement, it would perhaps be appropriate for the donor to abstain from votes that affect his or her DAF.


QUESTION - Pre-arranged Sale by Charity: Can a charity actually enter into a contingent sale contract with a prospective buyer and then have the property gifted to the charity?

ANSWER: Yes. While this process is not explicitly approved by the Service, it apparently will be successful. The charity offers the assets for sale and enters into a contingent contract for sale with the prospective buyer. The donor has no contact with the prospective buyer and thus there is no pre-arranged sale between the donor and prospective purchaser. After the contingent sale contract is in place, the donor transfers the property to charity and the charity then completes the sale. Once again, this is an aggressive strategy but appears to function successfully.


QUESTION - Straight Unitrust: Can I set up a straight unitrust with real property?

ANSWER: It is permissible to create a straight unitrust with real property. The problem is that the initial payments must be made and there may be insufficient income from the real property to make the payments. The common solution now is to use a FLIP trust. The trust is a net income plus makeup trust until the asset is sold on the following January 1. The trust then becomes a straight unitrust.


QUESTION - Term of Years Unitrust inside an S Corporation: Will a term of 20 years unitrust inside an S corporation produce ordinary income or capital gain? Will this income violate the passive income rules for S corporations?

ANSWER: The passive income rules for Subchapter S corporations apply if the S corporation has previously been a C corporation with earnings and profits. See IRC Sec. 1362(d)(3)(A). If greater than 25% of income is passive and there are prior C corp. earnings and profits, there will indeed be an adverse tax result. However, many Subchapter S corporations that have been long-term Sub S status can create a 20-year term of years unitrust. This trust may also produce, in large part, capital gain payments. Since the capital gain flows through to the shareholders, perhaps 2/3 of the payments flowing through to them may constitute capital gain.


QUESTION - Sale to ESOP and QRP: May a small business owner with a $2M business and several key employees use a unitrust and ESOP to transfer the business tax-free?

ANSWER: It is now possible to create an ESOP and sell the owner's stock to the ESOP. The proceeds may then be used to purchase qualified replacement property (QRP). This QRP will be a diversified portfolio of public stocks.
The owner may then use any of the unitrust, unitrust and sale, or unitrust and insurance trust strategies in his or her planning.


QUESTION - C Corp. Unitrust: May a C Corporation with $10M in value and $4M in debt use a term of 20 years unitrust?

ANSWER: Yes, the C corporation may create a unitrust. It would be desirable to use one of the debt-shifting strategies to move debt to assets that will be retained by the C corporation. The other assets that are unencumbered may then be transferred to the term of 20 years unitrust. There will be a bypass of gain and a charitable income tax deduction, usable to 10% of taxable income for a C corporation.
The best strategy is for a corporation to continue operation and thus be able to justify salaries for officers and employees. The term of years unitrust income is payable to the corporation. Yet, the income will be offset if it can be distributed as salaries to officers and employees.


QUESTION - Pre-Contribution Gain: What tier is pre-contribution gain assigned to with a straight unitrust?

ANSWER: Unitrusts under Section 664 must make payments under a 4-tier structure. The payments are first ordinary income, then capital gain, then tax-free or other income and finally return of principal. The pre-gift capital gain will generally be allocated to tier two, since assets usually are sold after being contributed to the unitrust. The straight unitrust must make the payments each year. The trust CPA will allocate all of the current ordinary income, and then the prior years' ordinary accumulated income to payments. If there still is an excess in the payment amount, then current capital gain and prior capital gain will be allocated to the payment amount. If the trust invests in a 70% stocks/30% bonds portfolio, it may be possible for 2/3 of the distributions to be reported as capital gain by the income recipients.


QUESTION - Reg Sec. 1.337(d): What is the meaning of "substantially all" in Reg. Sec. 1.337(d)?

ANSWER: If "substantially all" of a corporations assets are transferred to charity or to a charitable remainder trust, then gain is triggered under Reg. Sec. 1.337(d). The regulations make reference to Section 368(a)(1)(C). Under this "substantially all" definition, there is a facts and circumstances test. However, it appears that if 90% of the net assets or if 70% of the gross assets are transferred, then "substantially all" of assets have been transferred. The probable safe harbor for Reg. Sec. 1.337(d) is approximately 50% of assets transferred to charity or to a charitable trust. Given the Section 368(a)(1)(C) standards, it would be difficult for the Service to show that 50% is "substantially all".