My last piece (click here) on the so-called “Charitable Freeze” plan got so many viewers that I think we need a short follow-up. These types of complexities even cause me to glass over so getting the basics down first will help everyone understand the plan.
The key to understanding the Charitable Freeze is “discounts” – a term of art, of course. “Discounts” is a term that is used commonly in an estate planning/gifting context. In short, it is method for transferring assets at reduced values for reporting purposes.
Typically, planners will use a 30% discount when transferring assets/shares that are held in an entity (LLC, LLP, etc…) that entitles the transfer-or (i.e. rich parent) to claim that the assets/shares are worth less for “lack of marketability” and “lack of control”.
In other words, the recipients (i.e. kids) receive shares from an LLC or LLP – which are really worth the face amount but they have no ability to sell because good old dad holds those strings as the general partner or manager of the entity.
So, that $1 million in UPS stock that Mrs. Petter just put into her LLC, and then transferred the shares to her daughter gets reported as a $700,000 gift to her daughter (not the real value of $1 million).
Back to the Petter Case which confirmed that the Charitable Freeze works (for now). Mrs. Petter took a 51% discount! On the same $1 million example, she would only report a $490,000 gift to her daughter – nice deal for Mrs. Petter.
Taking a 51% discount is clearly a case of egging on the IRS to do battle. The so-called safe harbor (i.e. not likely to be challenged) is 30%.
My experience – and I am guessing the far majority of world – is that people do not like to go into financial plans knowing that it is highly likely that for the plan to succeed, it will need extraordinary amounts of LITIGATION!
So, back to the Petter Case and the Charitable Freeze. The Petters’ planner put in place an extremely aggressive discount – with a clause that prevents the IRS from actually collecting any more tax dollars should the IRS defeat the excessvie discount taken (funds going to charity instead – like a retroactive gift to charity that kicks in when the IRS beats you in court).
It may have paid off, but I wonder how much was spent in the litigation. And, just because they won, doesn’t mean others will and it doesn’t mean that the IRS will back off challenging aggressive discounts.
So, the verdict on Charitable Freeze is: buyer beware!