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Startup Employees: Defer Taxes On Equity With A CRT

By now, you’ve likely read our short primer on Charitable Remainder Trusts (CRTs) — the tax planning tool that most of our startup and crypto customers choose—and you’re probably comfortable with the basics. (If not, take your time, and we’re always happy to help jumpstart your learning with a quick phone call.) In this post, we’ll use a few examples, drawn from our real-world experience—to help illustrate the benefits (and, of course, the tradeoffs) of CRTs.

As we dig in, you’ll see pretty quickly that there are a couple of key decisions to be made: Should you choose a NIMCRUT or a Flip CRUT, and should your trust be set up for a set term or for your whole life? We address these questions in more depth in a series of posts on the features of each type of trust, and we’ll give you the numbers on each here. But we’ll focus on Lifetime NIMCRUTs, for a simple reason: The Lifetime NIMCRUT is the tax planning structure that has the largest return on investment, everything else being equal, so our customers typically choose the other formats only if they have other goals in mind besides maximizing returns. Maybe they want to guarantee consistent payouts no matter what happens in the markets (in which case a Flip CRUT might make sense), or maybe they don’t want to commit to a lifetime trust. You can get all of these same benefits out of a Lifetime NIMCRUT. (That was a lot for an aside in a short blog post, so, as usual, don’t hesitate to get in touch if you want to hear more from a live human expert.) Now, on to the cases!

Case study on minimizing taxes on appreciated Coinbase stock

Annie, Engineering Manager at Coinbase (Post-IPO)

Our first example, and the one that looks most like the majority of our users, is Annie, who lives in the Bay Area and joined Coinbase around the time of the company’s Series C round. She’s stuck around for the past 4+ years and worked her way up to a manager role, and she’s accumulated a decent number of shares in the process: Suppose that her shares—all exercised for a total cost of around $50,000—are valued at around $5 million. (We’ll note here that although Annie and Coinbase are post-IPO, this strategy works just as well–slightly better, in fact–with pre-IPO equity, so you shouldn’t hesitate to get in touch earlier in your company’s lifecycle.)

If she just sells her shares, Annie will owe the federal government about $1,055,000 in taxes on her capital gains, and she’ll owe California another $545,000, for a total tax bill of $1,600,000. That number is too big to stomach, so Annie would like to do some tax planning, and she’s chosen a Charitable Remainder Trust (CRT). How should she think about the details?

There is one key question that Annie, like everyone who is thinking about setting up a trust, will have to answer: How much of her Coinbase shares does she want to put into her trust? The sizing question is a personal one, because putting her money into a trust will affect her immediate liquidity (though not as much as you might expect), and so Annie will have to consider whether she wants to hold a bit back to take care of any immediate needs. Let’s say she has enough other savings and ongoing income to cover her expenses, and she decides to put all of her shares into a trust. How will the numbers work out?

Recapping the numbers

Cost basis: $50,000

Expected value at sale: $5,000,000

Immediate Charitable Deduction

The first benefit Annie will receive from putting her shares into a CRT is an immediate tax deduction. There’s some complicated math here, mandated by the IRS, but the bottom-line answer is simple: She’ll get to deduct about 10% of the current value of the shares she puts into the trust. In this case, that’s a $500,000 deduction. Since she lives in a high-tax state, the tax savings are substantial: That $500,000 deduction translates into cash savings of about $250,000 on next year’s taxes.

No Taxes On Sale

So Annie starts about $250,000 ahead of the game. But the biggest benefit of a CRT is that Annie gets to defer all of the taxes—state and federal—she would otherwise have owed on her big gain. So, assuming she decides to sell all of her Coinbase shares, instead of paying that $1.6 million we calculated above, she’d get to keep that money and invest it.

Available Withdrawals

We’re starting to see the numbers take shape, but there’s one more significant data point we haven’t gotten to yet: How does Annie plan to use her money?

One of the first questions our (very savvy) users ask us is the following: “These massive absolute gains are great, but will my money be locked up for the entire term of the trust? The answer, emphatically, is “No.” There are many ways to get liquidity out of a CRT, and we discuss them in some depth. But the simplest answer is that, due to the structure of NIMCRUTs, Annie (and you) will have access to a growing share of money every year, starting as soon as she reaches her liquidity event.

Assuming, for the reasons we discussed above, that Annie chooses a NIMCRUT, how much money would she have at her disposal every year? The answer is actually pretty simple: Every year after she sells her Coinbase shares, she’ll be able to cash out a set percentage of the trust’s current value. (For a term trust, it’ll be around 11%; for a lifetime trust, it depends on her age, but it’ll be right around 6%.)

The first thing to note, based on these numbers, is that Annie will receive a pretty decent windfall in the year she sells her shares—here, $300,000. That’s nice, and it allows her to pay off her student loans and take some time off.

But it’s not quite enough—she does have a few other expenses to plan for. She’s been saving for a down payment on a house, and she expects to make her move after a few years of letting her money grow tax free. Say she wants to buy that house in year 5, so she’ll need about $300,000. Can she do it?

Here’s a table showing how much Annie can cash out every year, assuming her assets grow 8% per year—right around the historical average for a diversified portfolio:

How much money Annie could pull out the first 10 years of her Charitable Remainder Trust

In other words, Annie will have more than enough cash available in Year 5 to make her down payment.

One technical—but very important—note here: Because Annie chose a NIMCRUT, these annual withdrawal allowances are cumulative; if she decides not to pull out the $324,000 she’s allowed in Year 2, that amount goes into her “make-up account,” and she can draw on it in a future year. So if she doesn’t touch her money in years 2, 3, and 4, then by year 5 she’ll actually have more than $1.4 million at her disposal (the sum of the available payouts in years 2, 3, 4, and 5).

Suppose Annie isn’t done. Life happens, and she expects to pull another chunk of money out in year 10 to pay for some expenses: A Tahoe cabin, a home remodel, her kids’ education. So she plans to withdraw $750,000 in year 10. We won’t spend too much time on Annie’s other decisions, but we know she wants to plan for her kids’ college tuition and she doesn’t want to be chained to a full-time job, so let’s say she wants an increasing amount every 5 years for the rest of her life.

Total Returns

What would all of these tax savings, investment gains, and withdrawals mean for Annie’s bottom line? After, say, 40 years, if Annie has her money in a Charitable Remainder Trust (CRT), she’ll end up with about $41 million in total payouts. About $17 million of that will go to the charity of her choice—that’s the bargain she struck when she chose a Charitable Remainder Trust, after all—so she ends up with about $24 million in her pocket.

If, instead, Annie had kept her money in a regular, taxable investment account, she would have instead ended up with about $6.6 million.

In other words, even after making what can only be described as a very generous donation to charity, Annie still pockets an extra $17 million, all because she put her Coinbase shares into a Charitable Remainder Trust back when they were worth comparative peanuts. Not a bad return on those shares she received when she joined a little tech company right out of college.

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