Charities run into multiple tax issues when looking to accept a gift of appreciated S-Corp stock, which do not burden gifts of publicly traded stock. First, the charity must report its allocable share of income earned by the S-Corp as unrelated business taxable income ("UBTI"), paying the resulting unrelated business income tax ("UBIT"). Second, whereas normally a charity does not generate UBTI when it sells an asset, a sale of appreciated S-Corp stock will trigger UBIT to the extent of the gain. Typically, the tax on UBTI for a charity is at high corporate rates, with only small offsetting deductions. Given these realities, practitioners should consider strategies to mitigate the UBIT so that more dollars are left for charitable purposes.
One popular technique in financial planning circles is to convert an IRA to a Roth IRA, so that the beneficiary will not have to pay income taxes on distributions from the Roth IRA in later years. However, the beneficiary of the IRA must typically pay substantial income taxes, since the IRA distribution (before it goes into the Roth) is taxable at ordinary income tax rates. One option is to offset taxes due on the conversion by simultaneously making a gift to a pooled income fund ("PIF"). Not only does this reduce taxes, but it provides cash flow for life to the income beneficiaries of the PIF, while (very importantly) benefiting charity.
Normally, charitable planners view pooled income funds ("PIFs") as being a great financial planning tool during life, and not a vehicle to transfer wealth. This case study may alter that assumption! Contributing to a PIF allows our donor to benefit charity, avoid potential capital gains taxes, transfer wealth to younger generations, and receive lifetime cash flow.
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