If you have a client who has a highly appreciated asset, such as shares of company stock with a very low or nonexistent cost basis or real estate, he may want to liquidate the asset to realize the gain, but capital-gains taxes may make this an unattractive approach.
However, if this client has other financial resources and does not need to access the asset for his personal benefit, it can be restructured to eliminate the severe tax consequences. For instance, if your client’s ultimate goal is for the asset to benefit his heirs, you could pose the question: “What if I could show you a way to essentially eliminate all the taxes, pass 100 percent of the asset’s value on to your heirs and benefit charity as well—would that be of interest to you?” Assuming the question sparks sufficient interest, I would then proceed with a presentation of the concept.
Gifting the asset
I would explain that because the asset has a very low or no-cost basis, selling the asset would have pronounced tax consequences and would actually erode the benefit of its sale. However, if we gift the asset to a charitable remainder trust (CRT) and allow the trust to liquidate the asset, it will not generate any taxation. As an added benefit, we can establish a family charitable foundation where the heirs can manage the trust, receive a management fee from the trust, as well as have the respectability of managing a charitable organization that can benefit the community at large. The family foundation would also immortalize the memory of its benefactor.
Once the asset is liquidated by the CRT, it is invested in a diversified portfolio that the advisor manages. Because the trust requires that an annual distribution be made, you can utilize a portion of the distribution to service a premium for a life insurance policy. This policy will prevent the client’s heirs from being disinherited by the gift of the asset to the charity. By having the life insurance policy owned by an irrevocable life insurance trust (ILIT), it is not includable in the insured’s gross estate.
Now the heirs have 100 percent of the asset amount that may be passed on to them without tax ramifications. For making a gift to a charity, the grantor gets a tax deduction in the year of the transfer and the succeeding five years to offset the income taxes on the distribution. (This is subject to applicable adjusted gross income limitations. The advisor will want to coordinate these activities with both legal counsel and an accountant.)
With this type of structuring, the client has taken a highly appreciated asset and liquidated it without realizing any capital-gains taxes. He has used the distribution to purchase a life insurance policy, assuming insurability, which will provide 100 percent of the asset’s value to his heirs without any estate taxes or income taxes. He has provided for the premium of the policy with income that most likely won’t have taxes paid on it, due to the deduction, and has left a substantial bequest to charity. Thus, it’s a win-win planning technique for him, his heirs, society and the planner.
Earl R. Borders III, CLU, ChFC, RFC, RHU, REBC, LUTCF, CRMS, is president of NAIFA-Ohio and president and chief operating officer of Hoovler Financial and Insurance Services in Columbus, Ohio.
For more of this month’s sales ideas, see “Full Coverage for Your Clients.”