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Tuesday July 16, 2024

Case of the Week

Stock Unitrust Payouts to Donors


Jim Thompson, a retired engineer, and his wife Janet Thompson, a retired nurse, are considering funding a term-of-years charitable remainder unitrust (CRUT) to benefit their favorite charity. Their favorite charity is raising money for the construction of a new building which would house a state-of-the-art theatre and museum. The Thompsons are active investors and have amassed quite a portfolio over the past few years. In particular, they have an investment in a medical services company that has quadrupled in value. They would like to use $800,000 of stock with a cost basis of $200,000 to fund a five-year CRUT with a 15% quarterly payout. However, they believe this company is a great investment with acceptable risk and prefer that the trustee of the CRUT not sell this stock. Furthermore, the Thompsons would like their CRUT payouts to be the actual stock – an in-kind distribution – as opposed to cash payouts. Thinking creatively, the Thompsons then wonder if such a distribution would avoid capital gain taxation since technically the stock has never been sold.


Can the Thompsons accomplish their goal of a tax-free 'in-kind' distribution of their technology stock? What are the tax consequences to the CRUT and to the Thompsons with this transaction?


Regulation 1.664-1(d)(5), which discusses in-kind distributions, states that the amount distributed shall be considered as an amount realized by the trust from the sale of the property. With respect to the Thompsons, their basis in the stock will be its fair market value (FMV) at the time it was paid to them. Therefore, the trust has an amount transferred of $120,000 (800,000 x 15%) in its first year. The trustee will realize $90,000 of the $120,000 as capital gain and $30,000 (200,000/800,000 x 120,000) as corpus. Under the 4-tier accounting rules of section 664(b), the Thompsons will report $90,000 of capital gain and the remaining $30,000 will not be taxable. Finally, the Thompsons new basis in the stock will be $120,000, which was its FMV at the time it was distributed.

Under this plan, the Thompsons receive a partly tax-free distribution. However, when considering their income tax deduction of over $360,000, approximately $500,000 of income over the five-year term, and a projected gift to their favorite charity in excess of $450,000, the Thompsons are very pleased with this arrangement. Because of their wonderful generosity, the Thompsons have the gratification of knowing they helped build a theatre and museum that will last a lifetime.

Published September 29, 2023
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