Florida Banking March 2024

TRUST AND WEALTH MANAGEMENT

BY MARK R. PARTHEMER, JD, AEP, ACTEC FELLOW FIVE LESSONS FROM RECENT PRE-SALE PLANNING CASES

ORIGINALLY PUBLISHED IN THE DECEMBER 2023 ISSUE OF THE NAEPC JOURNAL OF ESTATE & TAX PLANNING.

F or some estate and gift tax advisors counseling clients on succession planning, that dragon is the IRS. Many clients look to minimize the tax costs of business succession when selling to a third party, employees, other shareholders, or transitioning within the family. It may seem the IRS thwarts attempts to do so that are outside the lines of accepted planning and tax rules. This article examines five lessons to be learned from three recent cases and one Chief Counsel Advisory (CCA) in which the IRS challenged pre-sale planning techniques. Assignment of Income Assignment of income is the shifting of taxation from one party to another, a concept that has long been recognized in the Internal Revenue Code (IRC). Specifically, IRC Section 61 tells us that income from whatever source is to be taxed to the person or entity that earned it ( Helvering v. Horst, 311 U.S. 112 (1940)). To shift income to another taxpayer, the shift must occur before the income is earned. For those seeking to sell their business, the shift of ownership of some or all of one’s entity interests often is discussed. One strategy is to minimize the seller’s overall tax cost by contributing interests to others. One often used technique is to transfer some of the owner’s ownership interests to a tax-exempt organization. The recipient tax-exempt entity (TEE) could be a public charity, private foundation or donor advised fund (DAF). There are two reasons that this technique can reduce the tax cost: (1) tax exempt entities do not need to pay capital gains tax on the gains allocable to the shares it owns, and (2) a charitable contribution deduction can be generated by a contribution to the exempt entity. For now, let us focus on the first. For example, imagine a taxpayer is about to sell her company through a stock sale for $10 million. Her basis is $2 million. Were she to sell all of her

stock directly or indirectly (e.g., shares in a grantor trust), she would experience an $8 million gain. If she successfully contributed 25 percent to a TEE, and assuming no discounting, 25 percent of the gain would shift, reducing her taxable gain to $6 million – and in fact, no tax owed on the shares held by the tax-exempt entity. A variation is to spread the taxable gain among more than one taxpayer. Similar to a charitable contribution, this approach entails transferring to others, such as children or grandchildren, or into non-grantor trusts for them. This can shift some of the gain to those with lower effective tax rates, or even if neutral on tax rates, spread the gain among others. To be effective in implementing either variation or technique of this strategy, the transfers must be made before the income is earned, that is, before the company is sold. But according to a recent case, when the company is sold for assignment of income purposes is a gray area that can be a conundrum for taxpayers and their advisors. While it is clear that a company is sold no later than the date upon which the buyers furnish payment, for assignment of income tax purposes, the sale can be deemed to occur on an earlier date. That date is the one on which the sale is virtually certain or practically certain to occur. Imagine that a business owner receives an unsolicited offer from an unknown party to purchase the company for X dollars. If the owner says yes, has the deal become certain? Typically, it has not because after the parties come to an understanding, there can be non-binding letters of intent, purchase agreement documentation, due diligence, inspections, and more. So long as the buyer can walk away without a breach (e.g., no funds forfeited), we would conclude the sale likely has not become a “done deal.” The Tax Court focuses on the realities of the transaction, not on formalities or hypotheticals, such as the hypothetical possibility of abandonment.

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