by Steve Goodman
CPA, MBA – President & Chief Executive Officer
Contact Steve today for more info.
No presentation on succession planning would be complete without a discussion of post-succession activities.After building their businesses, doing the hard work to ensure a smooth transition to new ownership, and taking a well-deserved vacation, one still needs a focus in life. Increasingly, philanthropy has filled that void.Many business owners and managers find philanthropy to be new use for the skills they have spent a lifetime honing.
The Philanthropy Workshop (TPW) published a highly anticipated report in 2017 called “Going Beyond Giving”. The report looked at 219 donors to understand their motivations, interests, and how they went about deciding where to invest. Roughly 80% of the respondents reported a net worth in excess of $10 million, with 25% reporting a net worth in excess of $100 million.The results showed that older philanthropists looked at philanthropy as more an art than a science.Despite years of studying their own financial statements and those of the companies they may have acquired, relatively few showed serious interest in charity financials.Nor did they conduct a serious due diligence effort.Only 9% relied on third party charity evaluators.Peers, friends, personal and professional ties represented the lion’s share of decision criteria for the study respondents.
Increasingly, study respondents reported joining philanthropy networks. The 219 donors identified 101 such networks to which they belong.Just as angel investors increasing join angel networks for education and for common cause, so do philanthropists.It is often these networks that keep philanthropists informed of trends, regulations, and the science of giving.
The content of this article sources from Steve Goodman’s 2014 book Business Succession Planning.Mr. Goodman, CPA is a Long Island, NY based estate planning professional with 25 years of family wealth and business succession planning experience.
Business Succession Planning
If I ask you to name the wealthiest individuals or families from the early part of the twentieth century, what names would come to your mind first?Your list would most likely include Henry Ford, Andrew Mellon, John Rockefeller, and Andrew Carnegie.These individuals were certainly well known for their ability to amass great fortunes and their exceptional business skills.But their names have become part of the American story in large part because of their passion for giving their wealth away.These were the great philanthropists that came out of a booming age for entrepreneurs.While there were certainly those who inherited their wealth, many of the fortunes that came out of the early part of American history were created by individuals who created businesses.Rockefeller started out in business as a wholesale grocer.Carnegie was an immigrant from Scotland who started out at a low-level position in the railroad industry.Ford left the family farm to become an engineer.They all went on to build great wealth in various industries.And they all gave away substantial portions of their wealth to support the charitable causes they felt passionate about.
Jump forward to the twenty-first century, and there seems to be a similar movement afoot. There are individuals who have generated tremendous fortunes through their creation of successful businesses, and they are becoming the philanthropists our grandchildren will read about in their history books.People like Bill Gates, Warren Buffett, Gordon Moore, and David Packard are taking over where the Rockefellers and Carnegies left off.In 2010, Bill and Melinda Gates, along with Warren Buffett, developed the Giving Pledge, an effort to invite the wealthiest individuals and families in America to commit to giving the majority of their wealth to the philanthropic causes and charitable organizations of their choice, either during their lifetime or after their death.The pledge has recruited ninety-two billionaires to date, all publicly committing to give away at least half of their wealth.And while these are the names you hear in the media, countless other affluent individuals and families are taking their lead and turning their attention toward support of various social causes.
High-net-worth individuals in the United States are among the most philanthropic people in the world.The United States has the highest amount of giving as a percentage of GDP (1.67 percent), which is more than double that of any other country.And it is important to note that in the United States, as we get older, we get more charitable.In fact, according to The World Giving Index 2010 conducted by Charities Aid Foundation, North America shows the steepest rise in percentage giving money with age among all regions of the world with a 42 percent increase in giving from the youngest to the oldest age group.As it has been well documented that we have an aging population in this country, with the baby boomer generation approaching the age of retirement, interest in charitable giving is naturally on the rise.It is also interesting to note that entrepreneurs (households where 50 percent or more of their net worth comes from a family-owned business or a startup company) give the most to charity on average, compared to high-net-worth households that have other sources of net worth.
What does all of this have to do with business succession planning?For many business owners, their business interests make up a substantial portion of their personal balance sheets, and when considering a transition in ownership, whether by sale, gift, or bequest, it is important to consider many different aspects of your overall financial and estate planning goals during the planning process.For business owners who have a desire to utilize their financial resources to create a positive social impact, there are several ways in which their business succession and charitable goals may intertwine.First, I will discuss a strategy designed to accomplish a business owner’s charitable intentions and business succession goals.The remainder of the chapter will be devoted to a discussion on a rather recent trend often referred to as “venture capitalism” or “social entrepreneurship,” which may be of interest to socially motivated business owners who have successfully transitioned out of a business.
Selling a Business through a Charitable Bailout
Charitable bailout is a term used to describe the concept of transferring ownership in a business (typically to family members) by gifting all or a portion of the business to a charitable organization (or CRT) and having the charitable organization redeem the shares or sell the shares to the family members.There are numerous versions of this concept, but they all have the same basic features: a transfer of a business interest, a charitable contribution, deferral of capital gains taxes, a substantial income tax deduction, and removal of the business interest from the owner’s estate.
Here is an example of how a charitable bailout could work.You own a business (C corporation) and would like to transfer ownership to your two children who currently work in the business.The stock is valued at $15,000,000.The simplest option would be to gift the stock, but that could raise major federal gift tax issues and you really need to generate some level of income for retirement from this stock.Your children do not have the funds necessary to buy the business themselves but could use corporate profits to purchase the business if the payments could be stretched out for several years.You also intend to make substantial charitable contributions when you pass away.
A potential strategy would be for you to gift your shares in the company (or a portion thereof) to a charitable remainder unitrust (CRUT).(Interested readers are advised to see the Estate Planning section of this website for additional information about charitable trusts.)In a CRUT, the donor makes a contribution to the trust and receives income at least annually for a term (not to exceed twenty years) or for the life of the donor.Upon the death of the donor or the expiration of the term of years, the trustee distributes the remaining trust property to a qualified charity (or private foundation) chosen by the donor.The income is determined each year based upon a fixed percentage of the trust value.The donor receives an immediate income tax deduction for a portion of the gift, with certain limitations based on your adjusted gross income.The CRUT then may sell the stock to your children.
For tax reasons, it is important that there are no formal agreements to sell the stock to any particular party prior to the contribution of stock to the CRUT.The payment from the children would be in the form of installments paid out over a period of years.Based on the tax rules for payouts from CRUTs, any capital gains tax due from the sale of the business will be spread out over a period of time depending on the design of the trust payouts.Your children now own the stock and can use corporate profits to make their payments.When you pass away, the CRUT payments will end and the charity you named will receive the remainder of the trust principal.The business is no longer part of your estate for estate tax purposes and you will not have utilized any portion of your lifetime gift tax exemption.
Note that a CRUT is not a permissible S corporation owner; therefore, this strategy does not work with owners of S corporations.
Social Entrepreneurs: A Wolf Chasing a Different Prey
It only seems natural to wrap up the conversation on business succession planning by exploring thoughts on what to do after you have successfully transitioned out of your business.What does a business owner do after they have successfully transitioned out of a business?They are entrepreneurs at heart and have spent a lifetime with that mindset. In the nineteenth century, the French economist Jean-Baptiste Say stated that the entrepreneur was one who “shifts economic resources out of an area of lower and into an area of higher productivity and greater yield.”I have a slightly different, much less eloquent, view of what the entrepreneur is in the twenty-first century.An entrepreneur is someone who sees a hole in the marketplace and has the foresight to figure out how to fill that hole and the courage and intelligence to figure out how to make a profit filling that hole.It sounds simple, but not everyone has this ability.I have been very fortunate in my career to have worked with a lot of business owners, and I have found it incredibly enjoyable to listen to the stories of how they started their business.
One interesting thing I have noticed with business owners who have gone through the process of business succession during their lifetime is that they just don’t turn off the entrepreneurial mind-set.That’s like telling a wolf to become a sheep just because he’s not as young as he used to be.It’s not that easy to go from being the hunter to the hunted.The idea behind social entrepreneurship is to keep the wolf thinking and acting like a wolf, only changing its prey.Instead of hunting financial profits, the idea is to use your abilities to start hunting social profits.
A recent trend that is relevant to this discussion is that affluent philanthropists are increasingly looking for ways of having more control over their charitable gifts.Based on the 2010 World Wealth Report published by Capgemini and Merrill Lynch Global Wealth Management, “There is an increasing trend in modern philanthropy toward more so-called ‘giving while living,’ in which philanthropists are incorporating their giving strategies into their ongoing wealth accumulation and capital preservation plans.Today’s philanthropists generally want to make sure their giving actually makes a difference.”
This desire to effect social change, combined with the desire to have more control over their charitable giving, has led to an explosion in what has been referred to as the fourth sector.Organizations have traditionally been established as for-profit businesses, nonprofit organizations, or government entities.The primary goal of the for-profit business is to generate financial profits for the owners.The primary goal of nonprofit charitable organizations is to utilize donated financial resources to further a social or charitable purpose.The primary goal of government entities is to utilize taxpayer dollars to serve public needs.
This fourth sector that has been rapidly growing combines elements of each of the traditional sectors.These organizations vary greatly in their organizational structure, operations, source of funding, etc., but they have an important common characteristic: they pursue social purposes while engaging in business activities.I am not referring to businesses that are socially responsible or that make charitable contributions.These are businesses that utilize common business methods to achieve social purposes in addition to financial profits.As opposed to simply writing a check to a charitable organization or establishing a private foundation, social entrepreneurs across the world have been increasingly using their financial wealth along with their business skills, ingenuity, and creativity to develop businesses that have a social purpose.Bill Drayton, CEO, chair, and founder of Ashoka, an organization that provides both financial and consulting support to social entrepreneurs, stated, “Social entrepreneurs are not content just to give a fish or teach how to fish.They will not rest until they have revolutionized the fishing industry.”
Probably the best and most popular example of social entrepreneurship is Muhammad Yunus, who is largely responsible for introducing the world to microcredit for the poor. Yunus established the Grameen Bank in Bangladesh in 1983 in order to provide small loans to some of the poor in that country.The country had been wrought with famine for many years and Yunus was looking for a way to help.
Yunus was a professor of economics at a local university, so he took his talents—his intellectual gifts—and came up with an idea.The idea was to provide small loans to those who had a craft or a skill set in order to give them an opportunity at self-employment.Prior to the availability of the microloans, there was little opportunity for the poor to pull themselves up.The only loans available to them charged such high interest rates that the bank would take all of the profits.
The concept of microloans to help the poor has now spread to over one hundred countries and has helped millions of people break the hold of poverty.In addition to the social “profits” the bank has had, it also has financial profits.In the bank’s thirty-four-year history, it has recorded profits in all but three years. It recorded a profit of $5.85 million in 2009 and declared 30 percent cash dividend for the year—the highest cash dividend declared by any bank in Bangladesh in 2009.
For those business owners who have transitioned out of a business, still have that entrepreneurial drive, and have a specific social cause they would like to have a positive impact on, they may want to consider utilizing their skills to develop a business designed to generate a social profit.While the idea of making financial profits a secondary goal of a business may take some getting used to, there are a few key advantages to establishing such a business.For example, businesses that advance a social cause have a unique potential source of funds that typical for-profit businesses do not— program-related investments (PRIs) from private foundations.As long as the business meets certain qualifications, it may be able to accept grants or low-interest loans (even zero-interest loans) from private foundations in the form of program-related investments.
Private foundations are required to distribute a minimum of 5 percent of their net assets each year, referred to as a qualifying distribution.Typically, the foundation will simply make grants to charitable organizations to meet this minimum distribution requirement and invest the remaining balance.However, investments that qualify as PRIs will be considered qualifying distributions. In order to qualify as a PRI, the investment must meet the following criteria:
- The primary purpose of the investment must be to accomplish one or more of the charitable, religious, scientific, literary, educational, and other exempt purposes described in section 170I(2)(B) of the code.
- No significant purpose of the investment may be the production of income or the appreciation of property.
- No purpose of the investment may be to lobby, support, or oppose candidates for public office or to accomplish any of the other political purposes forbidden to private foundations by section 170I(2)(D) of the code.
When it comes to investing foundation dollars, the responsible parties must be careful not to violate the jeopardy investment rules.Sections 4944(a) and (b) of the Internal Revenue Code impose excise taxes on investments that jeopardize the foundation’s ability to carry out their exempt purposes.Additional taxes may be imposed if the jeopardy investment is not remedied within the prescribed time.
Section 4944(c) of the code makes an exception to the jeopardizing investment rules for “program-related investments” made by private foundations.Through PRIs, a private foundation can invest money in ventures that help to achieve the foundation’s charitable purposes.PRIs may take the form of investments in the business (essentially becoming a stakeholder in the business), or they may take the form of low-interest loans.
One exception to this particular source of funds for a business would be that the private foundation should not be the business owner’s family foundation, as this would most certainly violate the self-dealing rules of IRC section 4941.Currently, most foundations will only make a PRI to a socially supportive business after obtaining a private letter ruling that may be expensive and costly.Foundations are looking for assurances that the investment qualifies as a PRI.If it is later determined that the investment did not meet the criteria of a PRI, the foundation may be hit with excise taxes equal to 30 percent on the amount that the foundation should have distributed and 100 percent if the failure to make the required minimum distribution is not corrected.The Treasury has released regulations that provide several examples of what does and does not qualify as a program related investment, but considering the almost unlimited number of transactions that could be considered, foundations will typically still want to obtain a PLR.
In response to the growing number of businesses that operate with a social profit as a core goal and their desire to qualify for PRIs from private foundations, several states have created new forms of business entities.One such entity is the L3C, or low-profit limited liability company.Currently, there are nine states that have enacted L3C legislation: Illinois, Louisiana, Maine, North Carolina, Michigan, Rhode Island, Utah, Vermont, and Wyoming.Many other states have proposed legislation, and there is an effort underway to create federal legislation.One of the main goals in establishing L3C laws is to create an entity that prima facie qualifies for PRIs.Looking at the language in a typical L3C statute (Illinois in this case), we see that it closely mirrors the requirements laid out for PRIs.
Sections 1–26. Low-profit limited liability company.
- A low-profit limited liability company shall at all times significantly further the accomplishment of one or more charitable or educational purposes within the meaning of section 170(c)(2)(B) of the Internal Revenue Code of 1986, 26 USC 170(c)(2)(B), or its successor, and would not have been formed but for the relationship to the accomplishment of such charitable or educational purposes.
- A limited liability company that intends to qualify as a low-profit limited liability company pursuant to the provisions of this section shall so indicate in its articles of organization, and further state that:
- no significant purpose of the company is the production of income or the appreciation of property; however, the fact that a person produces significant income or capital appreciation shall not, in the absence of other factors, be conclusive evidence of a significant purpose involving the production of income or the appreciation of property; and
- no purpose of the company is to accomplish one or more political or legislative purposes within the meaning of section 170I(2)(D) of the Internal Revenue Code of 1986, 26 USC 170I(2)(D) or its successor.
A second type of business entity that has gained recent statutory authority is the “benefit corporation.” The major characteristics of a benefit corporation form are:
- a requirement that the corporation has a corporate purpose to create a material positive impact on society and the environment;
- an expansion of the duties of directors to require consideration of non financial stakeholders as well as the financial interests of shareholders; and
- an obligation to report on its overall social and environmental performance using a comprehensive, credible, independent, and transparent third-party standard. Benefit corporation legislation has passed in California, Hawaii, Maryland, New Jersey, Virginia, Vermont, and New York and is moving forward in several other states. In addition to branding advantages, benefit corporations also provide legal protection to directors and officers and the opportunity to receive capital contributions from different sources (i.e., program-related investments).
In addition to the potential for financial support from private foundations, by creating a business that has a social cause as a primary purpose, the business will have a growing network of support available to it.Organizations have been established to provide social entrepreneurs with both financial support and consulting services.There are also several universities who provide educational courses and research programs to advance the field of social entrepreneurship.(See list at the end of this chapter.)This provides a great opportunity for parents and grandparents to provide education for their heirs because gifts paid directly to educational institutions are not considered gifts for federal gift tax purposes (IRC section 2503
I).Speaking of children and grandchildren, there is an interesting strategy that business owners who have recently sold their business may want to consider.Take a portion of the proceeds from the sale of your business and gift it to a trust for the benefit of your heirs.With the federal lifetime gift tax exemption set at $11,180,000 in 2018, a married couple could gift as much as $22,360,000 with no exposure to federal gift taxes.The terms of the trust could be such that a child could be the trustee with the specific authority to manage the trust’s assets.As one who has the skill sets to develop and operate a successful business, you can personally assist the child in establishing a new business that has social profits in mind.The funds will be there to get it off the ground, and if designed correctly, they would have the added advantages of access to additional funding through program-related investments from private foundations.The child may receive compensation as an officer or employee of the company and may also receive distributions from the trust as beneficiary.If asset protection is a goal, a “friendly” co-trustee would be named with the sole right to make discretionary distributions to beneficiaries.The trust may also be designed to pass on to future generations (i.e., grandchildren).This strategy is a great way to pass on more than financial wealth to the next generation.It provides a means to spend time with family, develop core social values, develop entrepreneurial skill sets for your children, and provides a tax-efficient estate planning vehicle.
Organizations That Support Social Entrepreneurs (Financial and Consulting Services)
- Skoll Foundation
- Global Giving
- The Schwab Foundation
- Echoing Green
- Acumen Fund
- Draper Richards Foundation
- Kauffman Foundation
- Skoll Center for Social Entrepreneurship at Oxford University
- Social Enterprise Initiative at Harvard Business School
- Center for Social Innovation (CSI) at Stanford Graduate School of Business
- Center for the Advancement of Social Entrepreneurship at Duke University’s Fuqua School of Business
- Columbia Business School: Social Enterprise Program
North Americans are among the most charitable in the world. Much of that comes from the top 1% of earners. Many recognize that they have the capability to make a real difference in shaping society and improving the lives of others. More charitable foundations have been formed since 2000 than were founded in the previous 100 years.
Those with the skills and the capital to achieve meaningful results in the lives of others are increasingly realizing the quiet satisfaction of dedicating their retirement years to charitable pursuits.There are organizations to help these people become better donors. The tools to become a knowledgeable and effective donor are there for the taking. And to their credit, more business owners are contributing to a better world every year.
CPA, MBA – President & Chief Executive Officer
About Steve Goodman
For more than 30 years, Steven has provided insightful solutions to the challenges of business succession, wealth preservation and charitable planning, focusing on the needs of owners of closely held businesses and high net worth individuals.
He's been featured in the New York Times and is an accomplished speaker and has presented over the years to many organizations and professional groups on efficient business succession, estate planning issues and tax strategies. Steven is a CPA who was vice president of the Trust and Investment Division of JP Morgan Chase and a supervisor for KPMG Peat Marwick, and holds an MBA from Fordham University.