Tax-Smart Exit Strategies & Charitable Giving with a CRT

For a business owner looking to sell, the myriads of emotions and practical business needs that they face can be overwhelming. How do you sell something that you may have spent decades building? How do you ensure that you get the best price? What do you do next with your life post-sale? How do you lessen the tax impact that you will be faced with?

Ensuring that you have the right team of experts to guide you is a start. Putting thought into what you want to do next in life before you start the sales process is also of key importance.

This article will focus on some of the tax concerns that are faced during a business exit and how a tool like a charitable remainder trust can lessen the tax bite and build a foundation of “giving back” after a lifetime of business success.

Business exit planning can be a complicated process

Tax Reality Check

One of the first tax concerns is to be aware of the tax differences based on how a business is legally structured: C-corps vs. S-corps

• C- Corp Double Taxation Trap: If your business is structured as a C-corp, an asset sale (in which the buyer buys your assets such as real estate, equipment, client lists, and goodwill) ,instead of the legal entity of your business can trigger a doubling of tax that could swallow up to 50% of your sale proceeds.

-Corporate Level: Your business entity would pay a federal income tax on the value of the asset sale as well as any applicable state taxes.

-Shareholder Level: You, as a shareholder, gets a liquidating dividend after the corporation pays its taxes. You then need to pay a personal capital gains tax, a net investment income tax, and any additional applicable state taxes.

That is a lot of taxes. Buyers like asset sales because they receive a “step-up in basis”, allowing them to depreciate assets that they just bought from you. You as the seller just paid for their tax break at your expense. This is why C-corp sellers prefer a stock sale, selling the entire business as a legal entity, incurring only one level of capital gains tax.

• S- Corp Shares and the Recapture Sting: As a “pass-through” entity, the business itself does not pay a federal tax; the profit passes through to your personal return as the business owner. Although you are avoiding the double taxation of a C-corp, you are faced with a different burden: depreciation recapture.

Over the years of your business,  you have likely been “writing off” the cost of your business equipment to lower your taxes. However, Section 1245 of the IRS Code determines that at the time of your business sale, those deductions are considered a loan. When you sell those assets for a profit as part of the business sale, the IRS “recaptures” those previous deductions.

While the “goodwill” of your business (the value of your brand) can be taxed at a long-term capital gains rate of 15-20%, the amount attributed to deprecation recapture is taxed at income rates that could be as high as 37%. Determining how much the sales value of your S-corp is differentiated between “Goodwill” and “Equipment” plays an enormous role in determining how much of a “sting” you will face as the seller.

Charitable Remainder Trust (CRT): A Triple Tax Win

A CRT is a split-interest trust; the benefits of the CRT are split between the Income Beneficiary ( you as the business seller) and the Remainder Beneficiary ( the charity).

Timing is of utmost importance in this process. The CRT must exist first before the sale occurs. If the IRS determines that the CRT was created after the sale was agreed to, the IRS can ignore the trust and tax you personally.

The mechanics of a CRT and a business sale work as follows:

1. The Contribution: You transfer the business interest (i.e. stock) into the CRT before the business sale closes.

2. The Tax-Free Sale: The CRT is a tax-exempt entity. The CRT sells those business interests. It pays $0 capital gains tax and $0 depreciation recapture.

3. Reinvestment: Since there is no tax, the CRT invests 100% of the gross proceeds back into the trust.

4. Income Stream: The trust pays you (and/or spouse) an income stream for life or a specific term of years.

5. The Remainder: At the end of the trust term, the remaining sum goes to the charity(s) of your choice.

The CRT provides a benefit of a triple tax win:

• Elimination of Immediate Capital Gains: You bypass the 20% federal capital gains tax, the 3.8% net investment income tax, and state taxes at the moment of sale.

• Immediate Income Tax Deduction: In the year you fund the trust, you get a partial income tax deduction based on the "present value" of what the charity is expected to receive in the future. This deduction can often offset other income you might have.

• Estate Tax Reduction: Assets in the CRT are removed from your taxable estate. This is important for those sellers  whose sale proceeds might push them over the federal estate tax exemption limits ($13.99M per individual in 2025).

Final Thoughts

At the end of the CRT, additional steps can occur, such as founding a private foundation or having the proceeds gifted into a donor advised fund, building a charitable legacy that can proceed for decades and involving your future generations.

The processes involved in making sure your business exit can provide you the best tax benefits available and help plan for a future of significance can be complicated. Making sure you have the right advice and take the correct steps at the right moments in the process are of the utmost importance.

At Generosity Nexus, we can work with your existing advisors or connect you with the necessary experts to ensure that the sale of your business occurs in a way that is tax-advantaged and the foundation of a future of charitable generosity.

Don’t hesitate to schedule an appointment to learn more about how we can help you.