By Dr. Harold Wong for December, 2014 Publishers Auxiliary
You started your community newspaper 30-40 years ago with a dream. Against all odds, you competed with the large daily newspapers and carved out your local niche. However, none of your kids or grandkids wants to work the long hours that you do, where you are both the chief editor; sales manager; and even the weekend janitor. You got an offer to sell your newspaper and your spouse (who has worked by your side for decades) wants to spend more time with the grandkids. You are entering into serious negotiations with the buyer and then that little voice in your head says: “What are the tax and retirement planning implications of this sale?” This article will cover some of the major issues in this once-in-a-lifetime decision.
Case Study with Option 1: you (John and Mary Smith) have a firm offer to sell your community newspaper for $1,100,000. Your cost basis is $100,000 and so you face a $1,000,000 long-term capital gain. The long-term capital gains tax rate can be 20% if you have very high income ($457,600 or more for joint filing married or $406,750 or more for single filers in 2014). However, let’s assume that your income is lower and your combined federal and state rate for long-term capital gains is 20%. You would then have $900,000 left ($1,100,000 sales price less $200,000 of income tax).
Today, it’s very hard to earn much interest or dividend income. Over the last 6 years, 2% has been the average interest rate on a 10-year Treasury note or the average dividend yield for the stock market. After risking everything you have in your newspaper, you don’t want to take the risk of the stock market. You also understand that bond values will decrease sharply if interest rates increase in the future. So, you are concerned about putting your money in bonds. Yet, banks are not paying more than 0.5% on a CD, which would only be $4,500 of annual income. You decide to put all $900,000 in the bank until you have time to look at investment alternatives. You and your wife are both 70 and your combined Social Security income is $45,000. When we add the $4,500 of interest, total income is now $49,500. You never dreamed that your income from selling your newspaper for $1,100,000 would be so low.
Case Study with Option 2: Assume the facts are the same as Option 1, but you use the complex world of charitable planning to improve your situation. You transfer title of your newspaper to a certain kind of Charitable Remainder Trust (CRT). The CRT sells your newspaper for $1,100,000 and owes $0 capital gains tax. You decide to take a 5% payout from the trust, which starts at $55,000 per year and will pay out as long as one of you lives. If the CRT earns 7.82%, and pays you 5%, then it grows by 2.82% annually. You will receive 5% of whatever the CRT principal is. If the last spouse dies in 21.8 years, there will be a total of $1,625,323 of income to you.
Based on a complex calculation, you will also receive, in the year of the newspaper sale, $451,209 of charitable tax deduction. If you can’t use it all in the year of the sale, you are allowed to carry forward the deduction for as many as the next five years. The best way to use this deduction is to do a Roth IRA conversion of the $471,209 that you have saved up in your 401k and/or IRAs. By converting the full $471,209, which normally would create $471,209 of ordinary taxable income in the year of conversion, you now have $471,209 in the holy grail of tax planning, the Roth IRA. This means that there are no Required Minimum Distributions when you turn age 70.5, and there is no income tax at all on this money, no matter how much you earn. If you don’t spend it all by death, there is no taxation on this bucket of money during the lives of your kids and possibly even that of your grandkids. Note: you only have $20,000 taxable income from the Roth IRA conversion as you had $471,209 in your tax-deferred retirement accounts and the CRT tax deduction is $451,209.
What’s the downside to this type of planning? The CRT law says that that after the death of the last spouse the remainder of the CRT funds, but no less than 10% of the initial $1,100,000, would go to charities that you designate. In this example, the charity would receive the $2,015,599 in 21.8 years. But what about the kids and/or grandkids? You could use part of the CRT income, which starts at $55,000 in year 1, to purchase a life insurance policy that will result in $1-2 million death benefit (after the last spouse dies) and this could go to your heirs without any income tax. The life insurance policy would be held inside an irrevocable life insurance trust, or Wealth Replacement Trust, so that the $1-2 million death benefit is not counted as part of your taxable estate.
Summary: If you listen to Public Broadcasting TV or Radio programs, note that the sponsor is either a Charitable Trust or a Foundation. The strategy outlined above is how the super-wealthy, such as Warren Buffett can sell $billions of assets and not pay any capital gains tax. The same law also can apply to the owner of a community newspaper who wants to finally sell.