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Getting Some Estate Planning Help From Your Employees discusses and provides an example of how combining estate planning and ESOPs can help achieve the following objectives:

  • Providing a secure income for the life of the shareholder
  • Providing an equitable transfer to the heirs of the estate
  • Creating tax deductions and minimizing income taxes
  • Minimizing the taxable value of the estate
  • Taking care of the employees that contributed to the success of the company
  • Increasing the likelihood that the company will continue to exist and be successful
  • Providing a cost-effective, tax-efficient way to give to a charitable organization

The Virtues of Using ESOPs with Charitable Contributions discusses this complicated transaction in more detail. Here is a high-level summary of the steps:

1. Shareholder transfers company stock to a charitable remainder trust (CRT).

  • The shareholder (the donor) obtains a tax deduction for the charitable contribution equal to the fair market value of the company stock as of the date of the transfer.
  • After the CRT sells the stock to an employee stock ownership plan (ESOP) and reinvests the proceeds, the donor will receive income for a period of time, after which the CRT gains full control and usage of the proceeds.
  • The donor will avoid paying capital gains taxes on the stock.
  • The donor will get an income tax deduction for the interest that the trust earns.
  • The value of the estate of the donor has been reduced, reducing or eliminating estate taxes.

2. CRT sells company stock to an ESOP

  • This transaction allows participants that would be restricted from participation in a Section 1042 transaction (family members and 25% shareholders) to fully participate.
  • The debt assumed by the company to purchase the stock decreases the value of the company. Remaining shares can then be transferred to a family member or other shareholder at a lower cost.

3. Shareholder uses tax savings from the CRT to create a wealth replacement trust

  • The shareholder purchases life insurance policies to replace some or all of the property that would have been transferred to the heirs of the estate. The heirs will receive the insurance proceeds tax-free.

This method can also be an effective way to reinvest Section 1042 qualified replacement property.

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