As with most things in life, when things are bad, there usually is something good that can come out of it. Our current economic troubles have resulted in many closely held or small businesses being worth far less then they used to be. This is not a good situation for businesses that are hanging on to survive or have to be sold for various reasons. However, for people wanting to minimize estate and gift taxes and have been putting off taking a cold hard look at their estate plan, now may be the perfect time to explore the gifting of shares in their businesses.
For example, some businesses have senior family members who own all or most of the shares of the outstanding stock of their corporation. With the value of the business being down right now, more shares could be gifted to younger family members involved in the business.
Example: Mr. Senior owns 80% of Deflated, Inc., while his two sons who work in the business own 10% each. Deflated was worth $3,000,000 in 2007. By the end of 2008, it was worth $2,500,000. Mr. Senior talks to tax counsel and after exploring the tax strategies and planning tools discussed below decides to gift 20% of his shares worth $500,000 to each of his sons, leaving him with a 40% stock interest.
The tax advantages are as follows:
1. The stock gifted to each son was previously worth $600,000. The current market value of such stock to each son is now only $500,000. If Deflated, Inc. goes back to its value once the economy recovers, then Mr. Senior has just transferred $200,000 ($100,000 to each son) to his sons estate and gift tax free. At a current marginal estate tax rate of 45%, Mr. Senior’s family can save $90,000 (45%*$200,000).
2. The gifts to each son are gifts of a minority interest in Deflated, Inc. and such gifts lack marketability due to the limited market for such shares. Estate and gift tax rules allow discounts for these factors that reduce the value of assets transferred. These discounts for minority interests and lack of marketability conservatively can be 25%, sometimes more. With such discounts the gift of each $500,000 is reduced by $125,000. At a current marginal estate tax rate of 45%, Mr. Senior’s family can save another $112,500 (45%*$250,000).
3. Outright gifts of stock are eligible for the annual donee exclusion of $15,000 (2020 amount is adjusted for inflation). In addition, Mr. Senior has a spouse who will join in this gift, which will allow for a second $15,000 exclusion. So the taxable gift to each son is now reduced by $30,000 (Mr. Senior’s annual exclusion of $15,000 and his spousal joinder of another $15,000). Additional savings to the family is $27,000 (45%*30,000*2 sons).
4. If Mr. Senior makes no further gifts and dies with his reduced ownership interest of 40%, his estate can claim the minority interest and lack of marketability discounts against his remaining shares. If Mr. Senior dies in 2014, when Deflated is worth $4,000,000, his family can take a 25% lack of marketability/minority interest discount, saving his family another $180,000 (45%*$400,000 marketability/minority interest discount [$1,600,000 forty-percent interest*25%]).
Bottom Line: Mr. Senior can take advantage of the lousy economy, the lack of marketability and minority interest discounts and the annual donee exclusions with a spousal joinder to save his family a tremendous amount of future estate and inheritance taxes.
Caveat: Remember that this type of planning depends on the particular factual setting of each client and whether his estate is near or exceeds his available unified credit ($10,580,000 in 2020). One difference in the facts can change the outcome. Also, be aware that state inheritance taxes have not been considered in the above example. Finally, the above should not be considered as legal advice. Please consult with tax counsel to discuss your particular factual situation.