A power of attorney is a document in which you give someone else the power to act on your behalf for financial transactions.  Texas, like many states, has adopted a statutory durable power of attorney form.  The form has a laundry list of transactions from which you can pick and choose from, and you can add additional powers as you wish.  The most significant issue to decide is whether to make the power effective immediately or become effective upon disability.  The problem with making the power effective upon disability is that the powerholder will have to prove disability to the third party to whom the power is presented.  Accordingly, I usually recommend that the power of attorney be effective immediately.  Now there have been situations in my career, where husband and wife didn’t trust each other, and were insistent on making the power effective upon disability.  They probably should have come to see a marriage counselor, instead of an estate planning lawyer.

In certain cases, such as where the the client has complicated assets, it is recommended that the client go beyond the statutory form and prepare a power of attorney that addresses specific transactions that might arise in the management of these complicated assets.

Powers of attorney are a simple but important piece of any adult’s personal planning.  Usually used in the case of an illness or travel, they can be a lifesaver in more dire situations.  I remember years ago a client came to me with the follow situation.  Her husband had disappeared (his car was found abandoned on the way to work), but no body was found.  Since he couldn’t be presumed dead under Texas law for four years,  the wife couldn’t sell the family home.  With the husband being the sole provider, she was forced to give up the home in foreclosure.

Time to Lighten Up

With markets, both private and public, at all time highs, a lot of people are coming to me for ideas to mitigate the income tax hit of selling an appreciated asset.  There are a number of charitable structures that a client may want to consider (i) charitable remainder trusts, (ii) donor advised funds, (iii) charitable lead trusts and (iv) pooled income funds.

Pooled Income Fund-What is it?

This post will introduce an old idea that is finding a new life, the pooled income fund (“PIF”).  The concept of a PIF is quite simple.  The client gives an appreciated asset to a PIF, the PIF sells the assets and invests the proceeds, and the client receives the income generated by the fund for life.  PIFs have been around a long time, but, for various reasons, had gone out of favor.  Recently, given the low interest rate environment, PIFs have made a comeback.  Here is why.

Why is it Popular Again?

Given the low interest rate environment coupled with the rule that a PIF that is less than three years old can use the average of the last three years AFRs to calculate the charitable deduction means the charitable deduction for a PIF is substantially greater than a charitable remainder trust.  This is because the deduction is for the value of the assets remaining at the end of the term, and using a low interest rate to determine that value means that the discount for time is smaller.   When you couple this with the fact that most state laws allow the PIF to define income to include not only interest, dividends, rents and royalties, but also short and some long term capital gains, you have a very powerful income tax planning strategy.  We are finding charities very interested in working with us to create these donor friendly PIFs.

Bottom Line

A PIF can (i) produce an income tax deduction of 60-80% of the value of the substantially appreciated asset depending on the client’s age, (ii) avoid taxation of the sale of the substantially appreciated asset, and (iii) pay the client a lifetime income interest enhanced by a definition of income that includes some capital gain.  If the client takes a bit of the tax savings and purchases an insurance policy to cover the amount passing to charity and mitigate the risk of a premature death, he or she has all the bases covered.

I generally don’t recommend structuring a business as an S corporation.  Unlike LLCs and partnerships, the S corporation rules (i) restrict the number and type of owner, (ii) provide no flexibility in allocating income and loss, (iii) do not allow a step up of the assets at death of the shareholder and (iv) unlike other pass-through entities, the sale of assets and liquidation are both taxable events. This creates a sticky wicket to navigate.

Straight Stock Sale Tax Treatment Unlikely with S Corporations

A business sale can be structured as either a stock sale or a sale of the assets.  Buyers like asset sales because they can pick and choose what they want, and they do not inherit the existing liabilities of the company.  Sellers like stock sales because there is only one taxable event, rather than two.  However, even if an S corporation shareholder is able to negotiate a stock sale, the tax code allows buyer and seller to elect to treat the sale as an asset sale by making a Section 338 election.  Buyers like to do this because it allows them to step up the basis of the assets.  In a simple sale for cash the 338 election often works fine.  Assuming the asset sale results in a taxable gain.  It is passed through to the seller and taxed, and the gain increases his basis in his stock, so the distribution of the sale proceeds, which is deemed a sale, results in no gain because the basis in the stock equals the cash distributed.

Earnouts and Contingent Payments Cause a Sticky Wicket

The problem is that most transactions are not straight stock for cash.  Typically, a portion of the payments are made over time, and, when we introduce the installment sale rules to the mix, we find a huge disparity in tax treatment.  It is possible to have a situation where the seller has a large gain in the year of sale, but not enough cash to pay the tax.  That is a bad situation in its own right, but it can be made downright intolerable later when it turns out the seller reported too much gain in the year of sale, and only has a capital loss in later years that he cannot use.  A lot of these problems can be mitigated by structuring all of the sale consideration as notes, but that introduces business risk to the seller that the notes do not get paid.

Plan Ahead

Given the sticky wicket discussed above, an S corporation shareholder contemplating the sale of his company needs to consult with counsel before he starts the sales process.