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Thursday July 18, 2024

Case of the Week

Lucky Lucy Lindstrom's Long Shot Unitrust


Lucy Lindstrom finished college and headed west. She started as a financial analyst with a large company in Seattle. After just four years, she became a Registered Investment Advisor and began advising clients. Lucy also managed her own investments. With her keen insight into financial markets, Lucy began to move from traditional stocks and bonds into futures and commodities markets. Lucy was so successful in these markets that she now only manages her own large personal portfolio.

Somewhat late in life, Lucy discovered the wonderful world of philanthropy. She volunteered at her favorite charity and has learned that giving a helping hand to someone in need is even more gratifying than making another million in the futures market. After reading in a charity's weekly enewsletter about a charitable remainder trust, Lucy called Clara Johnson, the gift planner for her favorite charity.

Lucy recently invested $1,000,000 in a "penny stock" company. Recently, its stock rose from the $1 per share that Lucy paid to over $3 per share. Lucy thinks that the stock could move much higher next year, but she would like a charitable deduction this year. She asked Clara if she could use the stock to fund a unitrust, serve as trustee and hold the stock for another two years.


Would this plan work? May Lucy serve as trustee? Is it permissible to hold the highly speculative stock in the unitrust?


There are several potential obstacles to Lucy's plan. First, it is permissible for Lucy to serve as trustee. The trust document can include provisions to appoint an independent special trustee to handle hard-to-value assets or for other needed purposes. Either the charity or a corporate trustee could be the successor trustee. Second, a trust administration company can be hired to do the accounting and unitrust tax returns. This service is usually available for a reasonable 20 to 40 basis points per year.

The key issue is the unitrust's investment in the penny stock. Unitrusts are generally subject to Sec. 4944 rules on investments that may jeopardize the charitable remainder. Section 4944 imposes a tax on investments that jeopardize the carrying out of any of the exempt purposes of a private foundation. Regulation 53.4944-1(a)(2)(i) states that an investment shall be considered "jeopardizing" if the foundation managers have failed to exercise ordinary business care and prudence under the facts and circumstances prevailing at the time the investment is made. While no category of investments shall be treated as a per se violation, certain types of investments, such as those in futures, require scrutiny to determine whether the foundation managers have met the requisite standard of care and prudence.

There is an exception, however, for jeopardizing investments in property that are transferred to a private foundation or charitable trust by gift or bequest. If the asset is transferred to the private foundation by gift or bequest, then the jeopardizing investment rules do not apply. Reg. 53.4944-1(a)(2)(ii)(a).

While the exception does apply for assets contributed to the unitrust, Lucy should consider her trustee obligation under federal and state law to act with reasonable prudence. Under the state law standard, she may decide to diversify. However, by holding the stock, she may be within the requirements of Sec. 4944. Her professional advisor should help her make that determination.

Lucy decided to hold the stock. The company Lucy was invested in gained traction on one of its products. The stock soared to $10 per share and Lucy sold her stock for $10,000,000. She is now thinking about making a large gift from her unitrust to her favorite charity.

Published January 6, 2023

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