3 TYPES OF LIFETIME TRANSFERS FOR SMALL BUSINESSES ESTATE PLANNING CLOSELY HELD BUSINESSES

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For many business owners, their business is their greatest asset, source of income, and the culmination of a lifetime of work. Oftentimes, the goal is to pass either the business itself or its profits through the family to provide a livelihood for the next generation. This is certainly possible, but it takes deliberate and detailed estate planning in order to maximize your business’ value upon your death.
Benjamin Franklin reportedly said that “nothing is certain except death and taxes”. Unfortunately, one has to account for Uncle Sam during estate planning – especially when you have a small business. In a worst case scenario, your heirs could have to sell the business they were supposed to receive just to pay taxes! Thankfully, there are ways to legally minimize Uncle Sam’s share and transfer part or all of your business to the next generation. Here are INSERT HERE tools to consider when estate planning with your small business in mind:
1 – Buy-Sell Agreements
It’s generally a good idea to have a Buy-Sell Agreement for your business. This agreement is between the owners of a business and can cover a variety of topics from management, interest rights, transfers of interests, and how to assess the value of the interest. It’s never too early to establish a Buy-Sell Agreement, as they can usually be amended as needed.
Often times, Buy-Sell Agreements provide a set price or a formula for determining what an interest is worth. This is helpful because it can avoid disputes, prevent time-pressured sales that are below market value, and it is often looked upon more favorably by the IRS. Furthermore, you can make sure that the business stays away from that pesky relative or disgruntled rival by inserting a clause restricting the transfer of interest to a certain person. A Buy-Sell Agreement also provides information, helping you to plan your estate with more clarity.
2 – Lifetime Transfers
One important question is how much control you, the business-owner, are willing to surrender to others. This is a deeply personal and complicated question – and there is no right answer. However, keep in mind that surrendering some control of the business opens up more doors to protecting it. One benefit of lifetime transfers is that the appreciation in value (after the transfer) usually isn’t subject to estate planning taxes.
Before conducting a lifetime transfer, you should obtain an appraisal from a qualified CPA or business appraiser to determine the value of the business. With an estimated value in hand, one can better assess the tax consequences associated with transferring the business. Note that different kinds of transfers (and trusts) have different advantages and disadvantages. This list is not exhaustive. The following tools (unless otherwise noted) are types of lifetime transfers.
1 – Marital Deduction
The first tool we will discuss is called the “marital deduction”. Typically, someone can transfer an unlimited amount of assets to a spouse (or a specified trust) without incurring gift or estate tax liabilities if the transfers are made either outright or in a marital trust (before or upon death). Generally speaking, the surviving spouse needs to be a United States citizen. However, the assets are subject to the estate tax when the surviving spouse passes.
2 – Gift Tax Exclusions
The Lifetime Gift Tax Exclusion allows someone to gift assets (currently up to twelve million dollars) to a family member during their lifetime without paying a gift tax. The twelve million dollar limit is cumulative, but there is no requirement to spend it all at once (ex: two half-million transactions are also acceptable). Furthermore, there is an additional “annual gift tax exclusion”. The annual exclusion has a $16,000 limit (usually adjusted for inflation), and it works in addition to the Lifetime Exclusion. If your spouse consents, you can combine your annual gift tax exclusions to cover up to $32,000 worth of gifts (as 2022).
3 – Discounting
When someone purchases a minority interest in a business, the price paid is often less than the value of the interest transferred. On the flip side, purchases of over half of a business interest often pay what is called a ‘control premium’. The discount (and premium) exists because control over a property is important, so having an interest one doesn’t control is less valuable than it appears.
The concept of a minority interest still applies when gifting a partial interest in a business to a family member. Imagine that you gift your child a 10% interest in a company, which is worth $20,000. Since the 10% interest doesn’t allow the child to exercise control over the company, it’s naturally worth less. Valuing this $20,000 dollar interest at $16,000 is perfectly reasonable. Since the annual gift exclusion is $16,000, this gift doesn’t count against your Lifetime Exclusion Limit.
If you want to make a gift over the annual exclusion limit, you can (usually) either 1) pay the gift tax on the additional amount over the annual exclusion limit (ex: on $4,000 on our hypothetical transaction above), or apply it to the lifetime exemption. If this $20,000 interest were only transferred upon death, the minority interest discount would not apply, and the whole amount would count against the lifetime exclusion amount. The benefits of planned giving throughout one’s lifetime are evident!