How clients can use their businesses as engines for generosity
- Giving an interest in a business may enable owners to double their current cash giving, while dramatically reducing their tax liability.
- Most business owners are not aware they can give a portion of their business to charity.
- Giving an interest in a business generally has no adverse impact on the owners’ lifestyle, cash flow or capitalization of their business.
Hundreds of successful business owners throughout the country are discovering unique ways to use their businesses as engines for generosity. Take the Kuipers, for example.
Bill and Katrina Kuiper own and operate a pharmaceutical distribution company. The company produced about $1 million of net profit last year and was recently valued at $10 million. The business has grown by double digits from its inception 12 years ago, and it’s expected that the company’s performance will continue for the foreseeable future.
The Kuipers are a generous family that gives approximately $100,000 annually to various charities. In addition to supporting their local church, they are actively involved in local charities that support their city’s homeless community, and they have a deep passion for combating human rights abuses globally—especially human trafficking. They also give very generously of their time.
Considering their healthy annual income, Bill and Katrina live a relatively modest lifestyle. They live exclusively on the $200,000 salary that Bill receives from the company. Because of the high growth prospects the business has enjoyed from its inception, Bill has always reinvested most of his profits in the business. However, reinvestment has limited the Kuipers’ capacity for charitable giving. They would love to give more, but they simply lack the available cash resources with which to do so. Or so they thought.
Helping clients can make their charitable intentions go further
A savvy advisor recently shared a strategy with the Kuipers that allows them to increase their annual giving dramatically, even doubling their current cash giving, by using their most valuable financial asset—their business.
The Kuipers’ advisor explained how they could gift a relatively small interest in their business each year to secure the maximum charitable deduction allowed under existing tax rules. Taxpayers may generally deduct up to 50 percent of their income each year through charitable contributions. If a gift is made in the form of a noncash asset such as a business or real estate, the charitable deduction is limited to 30 percent of income.
So the Kuipers’ advisor encouraged them to make a charitable gift of an interest in their business equal to $300,000, 30 percent of their business’s $1 million income. Based on the value of their business, this represented a gift of a 3 percent interest ($10 million divided by $300,000).
The gift was intentionally made to a donor-advised fund for two primary reasons:
1. Because a donor-advised fund is classified as a public charity under the tax rules, Bill and Katrina receive a full fair-market-value deduction for their gift. Had they made a gift to a private foundation, their deduction would have been limited to their income tax basis in the business—which is quite low in comparison to the value of the business.
2. The donor-advised fund provides a mechanism allowing the Kuipers to make a single charitable gift but ultimately support numerous charities, as the donor-advised fund is merely a conduit to the end charities that the Kuipers support. Once the donor-advised fund receives cash—either from annual distributions of income from the business or proceeds from an eventual sale of the business—Bill and Katrina can then grant that cash from their donor-advised fund to any number of charities that they recommend.
Because Bill and Katrina are in the highest marginal tax bracket (45.6 percent combined federal and state), their gift provided a $300,000 charitable deduction saving $136,800 in taxes. The business interest gift increased their total annual giving from 10 percent to 40 percent of their income.
However, the Kuipers had an additional 10 percent of income that could still be offset by charitable contributions. Their advisor suggested they take a portion of the income tax savings that they had just realized from the business interest gift and make an additional cash gift that would be sufficient to use their remaining 10 percent deduction capacity. So Bill and Katrina made an additional cash gift of $100,000 from the $136,800 of tax savings. The additional cash gift also provided a charitable deduction, saving $45,600 more in taxes and taking their total giving to the maximum deductible amount, 50 percent of income.
The giving strategy described above had no adverse impact on Bill and Katrina’s lifestyle or on the capitalization and cash flow needs of their business. In fact, their cash flow actually increased due to the tax savings they realized. Despite the fact that the Kuipers gave $100,000 of the tax savings to charity, at the end of the day they still had $82,400 of additional cash flow from making these gifts—$36,800 after $100,000 of the initial tax savings from the business gift was made in the form of cash, plus $45,600 in tax savings from the subsequent cash gift.
Combining a vacation and mission
Most of the $82,400 of increased cash flow was reinvested in their business. However, they did use a portion of it to fund a two-week combined vacation and mission trip to Africa that had an unexpected, transformational impact on their lives. In addition to experiencing the beautiful sights and sounds of Africa, including an unforgettable safari, they had a unique opportunity to meet their ”adopted“ daughter, 9-year-old Christina, whom they’ve supported for years through a child sponsorship program with an international charity that combats child poverty. The Kuipers’ trip marked the first time in over 12 years that Bill had taken a full two-week reprieve from the demands of running a successful business.
Bill and Katrina are planning to continue this pattern of giving each year. Another benefit of this strategy is that their wealth, as represented by their business, will actually increase over time. That’s despite giving additional gifts in their business. Because their business is growing at double digits each year, and because they are gifting an interest in their business of only 3 percent each year, the value of their retained ownership continues to increase. At the same time, the Kuiper’s charitable giving has increased dramatically, to 50 percent from 10 percent of their income.
The Kuipers’ greatest joy comes from witnessing the lives that are touched and transformed by the charities with which they partner. The business-interest strategy they’ve implemented has enabled them literally to double their support for their charitable endeavors. That’s because their current cash giving has correspondingly doubled as a result of giving a portion of the tax savings generated from their business-interest gift. The Kuipers are also excited about the fact that at some point in the future, when their business is sold or liquidated, very significant additional assets will be available to support the charities they care about. This is a result they had never imagined possible until a creative advisor shared with them how their business could be a powerful engine for greater impact and generosity.
Copyright © 2017, Michael L. King. J.D. The content of this article is informational and does not constitute financial, legal, or tax advice. Individuals should consult and rely on the advice of their own financial, legal, and tax advisors.