You have 15 months to save on gift and estate tax.
When Congress and President Obama agreed to extend the Bush income tax laws in December 2010; the law also provided a window of time for business taxpayers to gift their wealth to the next generation.
The law not only kept the so-called Bush tax cuts and kept income tax rates at 35 percent, it also allowed the increase of the estate tax exemption and the gift tax exemption to $5 million for a time. Yes, the new law has a sunset, a time limit.
Like the story of Cinderella, the law ends at midnight on Dec. 31, 2012. There is a high probability that the law will expire and the new law will, in effect, raise income, gift, and estate taxes for many taxpayers. If the federal government does not make changes after Dec. 31, 2012, gift, estate, and income taxes will increase. The easiest path for Congress and the president will be to do nothing, let the Bush tax cuts end, and let the gift and estate tax exemption to reduce to $1 million. Today's law allows people to gift, tax-free, up to $5 million, or upon death up to $5 million is tax exempt.
Business owners have the opportunity to plan their gifting now in several ways and require thoughtful plans with several steps. The first step in gift planning is to have the company valued by a qualified business appraiser. It is important to consider having the business valued by an independent, professionally qualified business appraiser, because the planning may be scrutinized by the IRS in the future.
The business valuation will also include an appropriate analysis of discounts and adjustments to the company's value.
Owners should consider gifting within the next 15 months to take advantage of federal laws. There are several gifting strategies that benefit business owners under current law:
Annual gift exclusion: The annual gift exclusion of $13,000 allows a donor to give $13,000 per person per year without having to prepare a gift tax return. With the $5,000,000 gift exemption, taxpayers, including business owners, can give larger amounts to family members to benefit from the large gift exemption.
In addition, due to the lower value that many small and midsize companies have because of lower sales and earnings, the business value reflects uncertain conditions and puts a damper on the overall business value. As an example, a company worth $1 million in 2007 may be worth 20 percent less today due to the uncertain business climate. In this scenario, a family business owner can give 20 percent more shares due to the lower valuation with the same dollar amount.
Intentionally Defective Grantor Trusts: Another family business gifting tool that can be combined with the current $5 million exemption is the IDT. IDTs are trusts that are intentionally defective, because the grantor, person who establishes and gives assets to the trust, pays income tax on the income earned from the asset, such as a stock in a private business, given to the trust. The IDT ideally can receive stock in a business, real estate or other highly valuable assets. The benefit of the IDT for the next 15 months is the potential savings of estate taxes. The general concept is that the grantor transfers, sells, the trust asset to the IDT, and in exchange for the transferred business, the grantor-owner, receives a promissory note of the value of the business payable over an a period of time.
The business pays the grantor on the promissory note until paid off. The term of the loan is required to be 15 years to be in compliance with IRS rules. The $5 million exemption can improve this strategy. If the family business is worth $5 million, the owner can use all of his or her gift exemption and not need the IDT transaction.
If the business is worth $10, million, then half the value of the company ($5 million) can be transferred as a gift and the remainder transferred to the IDT. In this case, half of the business is exempt from the owner's estate and the other half would be estate tax exempt when the 15 year payment plan is paid in full.
Limited liability companies: The LLC can be established for family businesses and when appropriate the owner can begin gifting to family or management. LLCs in the State of Nevada also have the benefit of a new state law for asset protection, Senate Bill 405, which strengthened the asset protection for corporations and LLCs domiciled in Nevada. See your Nevada attorney for further details on the new law and legal advice. For any of these strategies, seek advice from your legal counsel and tax advisor for your individual needs and circumstances.
Scott T. Wait, CPA, is a shareholder in RS Wait of Reno and is an affiliate office of the McLean Group, a business valuation and merger and acquisitions firm. Contact him at scott@rswait.com or 825-7337.
