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Monday October 3, 2022

Case of the Week

Son's Intentions Paved with Gold -- Part 4


Several years ago, Martha and Frank built a very unique home on 45 acres of beautiful rolling hills and woods. Frank passed away three years ago, and Martha now solely owns the 45-acre parcel and home.

She enjoys the peaceful country view out her front window. However, the university adjacent to the property is very interested in acquiring the property for future growth. Not surprisingly, Martha is concerned. She does not want a new dormitory filled with college students in her front yard. In fact, she enjoys the peace and protection of her lovely home in the wooded countryside. However, at age 80, she recognizes that eventually some planning will have to be accomplished.

After obtaining a thorough understanding of Martha's needs and desires, Martha's attorney Paul, crafted a wonderful four-part solution, which incorporated an outright sale, a unitrust, a gift annuity and a gift of a remainder interest in a home. (See Case Study "Peace in the Countryside" for a full explanation.)

Another component of the plan involves the potential sale of the home to their son, Sam, after Martha's death. Specifically, Sam enters into an option agreement with the university. It is a contingent agreement that permits Sam to purchase the home from the university. This transaction is not an act of self-dealing and became part of the final plan. (See Case Study "Son's Intentions Paved with Gold, Part 1.")

However, Sam wants an additional option contract with Martha's unitrust. Specifically, Martha's unitrust will receive the 20-acre rear parcel, which the university intends on developing. In the event the university does not develop the land itself, Sam wants the right to purchase back the "family land" from the unitrust. However, Sam's potential transaction with Martha's unitrust is a prohibited act of self-dealing. (See Case Study "Son's Intentions Paved with Gold, Part 2.") Accordingly, the university and Martha's advisors strongly discourage such a transaction. Never liking to hear he cannot move forward, Sam retains his own counsel.


Despite the prohibition on self-dealing, may Sam nevertheless purchase the 20-acre rear parcel from the unitrust? What types of penalties may be imposed on Sam?


Charitable remainder trusts, charitable lead trusts and private foundations are subject to Section 4941 which prohibits acts of self-dealing. Self-dealing means any direct or indirect transfer to, or use by or for the benefit of a disqualified person of the income or assets of a private foundation or charitable trust. Consequently, a disqualified person may not buy, sell, lease or otherwise transact business with a charitable trust or foundation. If an act of self-dealing occurs, then an excise tax may result.

The rate of tax is 10% of the amount involved. In this case, the amount involved is $1 million, which is the fair market value and selling price of the 20-acre rear parcel. Therefore, the tax may equal $100,000 ($1 million x 10%). Furthermore, if the act is not corrected within the taxable period, a 200% rate of tax may apply. Thus, the tax may increase by $2 million ($1 million x 200%)!

The tax is imposed on any disqualified person who participates in an act of self-dealing. In general, disqualified persons include lineal descendants of a donor. For example, children and grandchildren of a donor are disqualified persons. In this case, Martha created the unitrust and Sam is a lineal descendant of Martha. Therefore, Sam is a disqualified person with respect to Martha's unitrust. As a result, Sam may be liable for the self-dealing excise tax. This is true regardless of the potential benefit to the unitrust. In other words, Sam's offer to pay a fair market value price will not negate the application of the self-dealing rules.

Based upon Sam's counsel's findings, Sam wisely decides to avoid the 20-acre rear parcel purchase plan. The potential self-dealing taxes quickly turn Sam's interest away from purchasing the 20-acre rear parcel. Nevertheless, Sam finds solace in knowing he will purchase the family home – the most important component of the family land – from the university at some future date.

Published October 1, 2021
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Son's Intentions Paved with Gold -- Part 3