Creative Charitable Strategies for Clients with Sub-Chapter S Shares Bryan Clontz, CFP® President, Charitable Solutions, LLC

Agenda UBIT Definition and Overview UBIT Exceptions UBIT and S-Corp Stock: A Summary UBIT Solution: Dechomai Asset Trust Trust Rates vs. Corporate Rates UBIT Case Studies UBIT Resources/Articles

UBIT Definition and Overview Code Section 512 defines UBIT as income derived from an unrelated trade or business – UBIT has existed for nearly 60 years Tax is paid at either corporate or trust rates Charities must file 990-T and publicly disclose UBIT section IRS may audit UBIT compliance/accuracy Practical applications and compliance of UBIT are particularly complex UBIT typically arise with S-Corp stock, real estate with debt or real estate with active service income Some charities automatically decline UBIT gifts

UBIT Exceptions Passive Income – rents, interest, gains, dividends, royalties, etc. 1. Exception – debt financed income Exception – mortgage for 5 years and owned for 5 years “old and cold” 2. Exception – S corporation income Charitable Remainder Trusts are not exempt from UBIT, charitable gift annuity contracts are exempt under acquisition indebtedness rules IRC 514(c)5 but the funding asset is not exempt

UBIT and S-Corp Stock: A Summary There are more than 3 million S-corporations - about the same as C-corporations and LLCs combined – with nearly 6 million shareholders In 1998, Congress allowed charities to be qualified shareholders of S-corporations but not CRTs Charities would have to pay UBIT on passive income as well as any pre- and post-contribution gain Donor receives a fair market value deduction (less any ordinary income reduction) on stock

Trust Rates (basically the same as individual rates) 15-35% with the top bracket hit at $10,450 Capital gains are taxed at 15% Corporate Rates 15-39% but are constructed to average 34-35% Capital gains are income First bracket at 15% is up to $50K, last bracket is 35% over $18.33M in taxable income Taxation – Trust vs. Corporate Rates

UBIT Solution: Dechomai Asset Trust Donation Flow Step 3 –Dechomai Asset Trust Grants Net Proceeds to DAF at American Endowment Foundation (AEF) Step 2 – Dechomai Asset Trust Sells Shares Step 1– California Donor Contributes S-Corp Stock to Dechomai Asset Trust, A Nevada Public Charity Deduction: $1M of S-corp stock with $200K adjusted basis UBIT at trust rates 15%) = $120K in tax Trust receives a 50% of AGI deduction to reduce tax to $60K plus $25,000 charitable fee or $85K net with $915K to charity; If donor sold asset, gift/deduction would have been $800K (25% tax federal and state)

Case Study Investment Advisor Selling to Jr. Partner Public Charitable Trust With a Donor Advised Fund Sells to New Partner/15% Gains Tax Reduced by 50% for Deduction Donor Receives a 100% FMV Deduction. Donor’s DAF at AEF Receives Net 93% of Gift as Grant Vs. Sale and Gift of Proceeds Netting 77% to DAF at AEF. Donor Contributes S-Corp to Trust-Form Public Charity in Nevada (Income Tax-Free State)

Joe Smith Sells 80 shares Buyer Dechomai Asset Trust Smith DAF with AEF Cash Sells 20 shares Cash UBIT Deduction Donates 20 shares Income Tax Deduction Charity ACharity B Charity C Grants Grant recommendations

1234 Client Sells Shares, Then Gives Proceeds to AEF Client Gives Shares to DAT, Then DAT Grants Net Proceeds to AEF Client Gives Directly to a Corporate Form Public Charity Client Gives to a Private Foundation Total Donor Tax Savings Less Taxes Paid600,0002,000,000 0 Total Amount Left for Charitable Giving4,000,0004,475,0003,425,000 4 Scenario Summary Assumptions: S-Corp Shares FMV$5,000,000 Cost Basis -0- Federal Tax (Ordinary Income) 35% Federal Tax Rate (Capital gains) 15% State Income Tax 5% Scenarios

UBIT Resources and Articles American Endowment Foundation Tools: Flow Chart and Worksheet The Tax Law of Unrelated Business for Nonprofit Organizations by Bruce Hopkins, John Wiley & Sons (2005). “Tax Savings Opportunities for Charities Owning Subchapter S Stock,” by Laura Peebles – Planned Giving Design Center “UBTI in Charitable Planning” – 2008 ACGA Conference by David Wheeler Newman “Gifts from Subchapter S Corporations and Their Shareholders,” by Chris Hoyt and Pam Segars – 2006 NCPG Conference