How Can I Eliminate Capital Gains Taxes on the Sale of My Business? Well, capital gains taxes are … wait for it … voluntary. Federal estate taxes are … voluntary. Generation skipping, gift tax, and so forth are … voluntary. You don’t have to pay capital gains taxes on the sale of your business or real estate as long as you support the social well-being of the country in a way that is in alignment with what is important to you … which could be your own family foundation.
Like many business owners, Jack Montgomery and his advisors carefully planned the sale of his business. Using the best recommended sale strategies, he was anticipating a smooth transition into his ‘Golden Years’. With the sale of the business almost complete, his thoughts turned to two remaining tasks, paying the taxes and beginning his retirement with the money acquired from the sale.
Although he was happy with the business sale, at this late stage two harsh realities were emerging. First, the tax bill on the earnings was larger than planned. Second, now that Jack was receiving money from the business sale, what would he do with it? That’s when Jack’s advisor suggested that he contact me to ask my advice on managing the $6M net assets he would receive… a lot to manage over what he hoped would be a lengthy retirement.
We chatted for a few minutes. As Jack talked, I discovered that he was selling his business as a stock sale – not an asset sale. His ‘basis’ in the business (the net value of his cash contributions) was next to nothing… not an uncommon occurrence. This meant the true starting value of the sale was $8M with a resulting $2M tax bill. Jack was naturally disappointed with the high amount of taxes he would have to pay from the sale of his business, but his thoughts were now focused on what to do with the remaining $6M.
How Can I Sell my Business and Eliminate Capital Gains Taxes?
I asked if it would be ok to discuss ways he could eliminate the $2M tax, and end up with the entire $8M net. “Sure,” he responded, “but how can I eliminate capital gains taxes while selling my business?” I briefly explained that capital gains taxes are ‘voluntary taxes’… along with federal death taxes (also called estate taxes), and to some degree income taxes. It is possible to eliminate these taxes – and not go to jail! “How do you do that?” he repeated, and I replied, “let’s get together, and we’ll talk about how that can be done!”
What I told Jack when we met is that “by eliminating capital gains tax he would be able to preserve his wealth, and pass on a legacy of helping others. And in fact, there is a creative way to sell appreciated capital assets (his business) and eliminate capital gains taxes. Another advantage, it provides asset protection and reduces potential estate taxes, while still providing income from the asset. At the same time, it does good things to help others after he is gone…”
This tool has been around since the 1969 Tax Reform bill… that’s a LONG time when it comes to tax law. It has gone through a few modifications, but those modifications have really only served to make this tool better and clearer… Then I reminded him, (for the sake of my professional liability attorney) … I am not an attorney. This is not to be considered a legal opinion or legal advice. I do not practice law, and he will need to engage competent legal counsel before engaging in the use of this technique.
With that out of the way, I began the explanation he’d come to hear. “I call this tool a Capital Gains Elimination Trust™ (CGET), but the technical name you may have seen before is a ‘Charitable Remainder Trust’ (CRT). It comes in two ‘flavors’ which I will unpack shortly …
This is not a terribly ‘sexy’ tool … pretty straight forward as planning tools go. It is not a ‘grey area’ tool … it is right down the center of the fairway to use ‘golf speak’. There are different ways we can make the Capital Gains Elimination Trust™ a bit more unique than the plain vanilla tool, but it’s widely used in higher end tax planning. It has a number of benefits and a few drawbacks… so I’ll give you the good news along with the bad”.
Capital Gains Elimination Trust™ or ‘Charitable Remainder Trust’.
- Contributions to the trust create a tax deduction of at least 10 cents for every $$ contributed. If you are older, or the amount of income you take out is less, it creates even more deductions today!There is a limit to how much can be deducted, but you have six tax years to use it up… and most clients do so in the first few years of creating this tool.
- The money once in the trust (assuming there is no “transfer with the intent to defraud creditors”) is free from any creditor claims.
- The money in the trust grows without tax.
- Assets can be sold in the trust without creating a capital gains tax.
- The assets are removed from your estate for calculating estate tax – or said another way, there is no estate tax calculated on the assets in the Capital Gains Elimination Trust.
- You receive an income stream that can be “shut down” until needed and then opened up – or after you make the transfer – or after an asset is sold (such as real estate which carries a lower income stream usually until it is sold and then “flipped” into higher income producing assets …and “yes” … this version is called a “Flip Trust” for that reason!).
- It can be invested by whomever you wish.
- You and/or your partner can be trustees if you wish – collect a trustee’s fee in addition to the income from the trust – and it still does not create inclusion in your estate for estate tax purposes.
- The asset principal once placed in the CGET cannot be withdrawn – the income comes out if desired, but not the principal.
- Whatever assets are left in the trust after paying you income for the rest of your life (or lives if more than one person is receiving income) goes to the charity of your choosing – which could include your own family foundation. (This is not a negative to most people, and we can buy life insurance to replace the lost value of the asset, and the tax savings is often enough to pay the insurance premium in many cases. It’s like having Uncle Sam pay the premiums for your life insurance.)
- This is not free – someone has to administer the trust and file the tax return – which could be you. (Your CPA can also do this, or an outside service. We do have a CPA within the Team that will administer the trust for a maximum fee of $2,000/year no matter the size, and less depending upon account size.)
Two flavors of a Capital Gains Elimination Trust™:
- The income remains the same every year and does not go up or down with the fluctuations of the account size.
- The income goes up or down depending upon the value of the account. If the account goes up over time, so too will your income. (This is the most popular form of the two by far.)
“So, Jack, there you have it… a way to eliminate capital gains taxes while selling your business or any appreciated capital assets, convert to a ‘voluntary taxpayer’ and preserve more of your wealth, manage your $8M assets after the sale and still make a significant difference for your heirs and your favorite charitable causes when you are gone.”
Written by R. J. Kelly – February 2013