Case of the Week
Southern Brat Delicious Lead Trust Bailout
Case:Peter and Sue Olson were raised in the great North Country. After college, they were married, and Peter accepted a position with one of the nation's largest discount stores. He rose through the ranks and finally was promoted to be manager of the New Orleans branch of the store.
Peter and Sue lived in a suburban area of New Orleans and he was quite successful at managing the store. Each weekend, Peter enjoyed his hobby of grilling bratwurst sausages on his barbeque. Peter recognized that brats were a well-known delicacy in the north, but were a relatively new phenomenon to his southern friends. So Peter frequently invited friends and neighbors over for a brat and sweet iced tea gathering.
Peter and Sue were thinking about becoming entrepreneurs, so they started a small business, the "Southern Brat Deli." To their great surprise and mutual joy, their southern customers were delighted with brats and sweet tea. The Southern Brat Deli flourished and Peter soon opened another store—and then another and another and another, until there were ten Southern Brat Delis stretching across Louisiana and Mississippi.
On the advice of his CPA, Peter had incorporated Southern Brat Deli, Inc. as a C Corporation. He was able to operate efficiently and Southern Brat Deli, Inc. grew and flourished under his leadership. Over time, the Southern Brat Deli, Inc. acquired various diverse assets and business interests, in addition to the ten locations of the Southern Brat Deli.
Peter and Sue had two children, William and Mary. After William and Mary finished college, they both joined the Southern Brat Deli. William is Vice President of Marketing and Mary is Vice President of Human Resources.
When Peter passed away, he transferred the Southern Brat Deli stock to Sue. She would like to transfer the Southern Brat Deli, Inc. stock to William and Mary. Sue also plans to fund a supporting organization with her favorite charity. Her attorney, Clara Simpson, advised Sue to consider a charitable lead trust. Clara indicated that with the charitable gift tax deduction and her available gift exemption, Sue could transfer Southern Brat Deli, Inc. to William and Mary.
Question:Would this plan work? How long should the lead trust last?
Solution:A private foundation that holds more than 20% of a corporation's stock or business interest may be subject to the excess business holdings rules. These rules impose a tax on the business enterprise holdings of a private foundation in excess of the permitted holdings defined in Sec. 4943(c). The excess business holdings rules are intended to discourage private foundations from unfairly competing with for-profit businesses by virtue of their tax-advantaged status. Section 4947(a)(2) applies the excess business holding rules to a lead trust if the charitable deduction for the charitable lead interest exceeds 60% of the total lead trust value. Sec. 4947(b)(3).
William and Mary currently each own 5% of the stock and their mother Sue owns 90%. With the transfer, the lead trust will hold 90% of the stock. Under Sec. 4943(c)(6), if a private foundation acquires stock by gift or bequest, it has a five-year grace period to dispose of the stock to avoid the application of the excess business holdings rules. Sue consults with her attorney who determines that if the lead trust lasts for five years, it may fall under the grace period. The lead trust will reduce the taxable transfer to William and Mary. To further reduce the taxable transfer, Sue transfers her stock to a family limited partnership (FLP). The FLP units are then placed in a five-year lead trust. With the double discount for both the FLP and the charitable gift deduction for the lead trust, her gift exemption covers the present value of the gift to William and Mary. For the five years, an annual annuity is paid to charity to fund the supporting organization. The annuity amounts to charity each year are provided through a dividend from Southern Brat Deli to the FLP.
After five years, William and Mary receive the Southern Brat Deli FLP units from the lead trust. They now own the entire business. Both are reported to have celebrated with a dinner of brats and sweet iced tea.