Illustration: How an Accelerated Charitable Trust works:
John and Mary Diligent, ages 35 and 32 respectively, have a 2 year old son, named Junior. John and Mary both employed by Cyber Corporation, have had the good fortune to be granted 100,000 shares of Restricted Stock and 10,000 shares of Incentive Stock Options from Cyber which they both intend to exercise. They are considering selling the shares of stock after requisite holding periods. Because of a long wish list (a new car, an addition to the home and the payoff of their mortgage), John and Mary have decided to liquidate 50% of the stock to meet their immediate spending desires. They have elected to devote the balance of the stock, however, to build their wealth for the future. This stock has a cost basis of $30,000 and a current fair market value of $1,000,000. John and Mary will transfer the shares of stock to an Accelerated Charitable Unitrust, under which they will be paid 43.75% of the value of the Trust every year for, as long as they are alive, the 4 year term. Principal will be used to make these payments if income is not sufficient. If John and Mary die during the 4 year term, the 43.75% income stream will be paid to Junior for the remainder of the 4 year term, as long as he is alive. At Juniors death, or the conclusion of the 4 year term, the Trust principal will be paid to ABC Charity. John and Mary may designate other charities in the future.
John and Mary plan to leave Cyber Corporation soon after its Initial Public Offering. They hope to get a job with a start-up company BukuBucks.com and receive in their compensation packages: Founders Stock, Restricted Stock or Incentive Stock Options. John and Mary will use their Accelerated Charitable Trust to completely avoid the income taxes they face in the future on BukuBucks.com stock or other assets.
The Trustee will pay John and Mary $490,000 in the first year of the Trust, which amount will decrease every year of the Trust as the Trust assets are quickly depleted by distributions back to John and Mary. They will have a major tax savings in the year of creating the Trust because the present value of the accelerated charitable interest will qualify for an income tax charitable deduction in the amount of $100,000 (which will prevent John and Mary from having to a write a check to the IRS and DOR in the amount of $45,550). At John and Marys death, there will be no gift or estate taxes paid on the transfer of the income stream to Junior, nor on the event of the ultimate disposition of the Trust assets to ABC Charity.
If John and Mary had simply sold the securities, they would have realized a gain of $970,000 on which there would be partially ordinary income and capital gains taxes totaling $441,835, leaving them with a net of $558,165.
The comparison is striking. By creating the Trust, John and Mary get an immediate tax deduction of $100,00, and they avoid paying $441,835 in ordinary income and capital gains taxes at once. But even more significant is the heightened value of the tax-free compounding and income stream over the 4 year term which is available to John and Mary solely because of the Trust. Assuming John and Mary, or Junior, live for the 4 year term, the cumulative, post-tax disposable income (i.e., purchasing power) created by their annual distributions, earning an average rate of return of 12%, will be $1,099,869. In sharp contrast, if John and Mary had sold the securities, paid the capital gains tax up front and invested the balance at the same rate of return, the cumulative post-tax disposable income would be $648,082. The difference is that with the Trust, John and Mary would earn $451,787 or 69.7% more than they would otherwise earn.
The following chart displays the exponential growth in post-tax disposable income that can be realized with the use of the Accelerated Charitable Trust.