Financial TipsAlan S. Moore / L’Observateur / November 1, 2000Passing a closely held business between generations can be a smooth transition, as long as someone competent is available to take over management. Passing the business with minimum tax impact is anothermatter. Careful planning is essential to preserve your assets. Lifetime gifts to other family members are a proven way to pass business assets and save estate taxes as well. With proper structuring of the gifts,total gift and estate taxes can be minimized or even eliminated in some cases. A lifetime gift works well because it removes from the giver’s estate(and estate tax liability) any appreciation in the gift assets that occurs after the gift is made. A sizable annual exclusion from both gift and estate taxes(up to $10,000 per recipient – $20,000, if both spouses give) simplifies transferring assets over a multi-year period. A larger one-time gift can bemade by using the applicable exclusion amount, which is currently $675,000 (increasing to $1,000,000 by 2006) Here’s an example of how gifting can work. You are the sole owner of City-wide Widgets, which today is worth $900,000. You are looking towardbecoming less active in the business and want to start transferring ownership. Joined by your spouse, you give your two sons and daughter$20,000 worth of stock each annually without any gift tax liability. Afterjust six years, your tax-free transfers will total $360,000. You’ll reduceyour estate by the entire $360,000 because both the $360,000 value and any subsequent appreciation in stock value are excludable from the estate.
Published 12:00 am Wednesday, November 1, 2000
If you are in today’s top estate tax bracket, your potential tax savings will be $198,000!
Save More with a Minority Discount
Are those $20,000 gifts in the example really worth the entire $20,000? Not when you consider that yours is a closely held corporation, and no minority shareholder can influence management or liquidate the company.
So, in general, minority shares in closely held companies are valued at a discount from their proportional share of the company’s full value. That canlet you give away more shares each year within the gift tax annual exclusion limit.
For years, a minority interest discount was a problem with the IRS if the gift was to a person within a family that owns all, or the majority, of the corporation’s stock. The IRS formerly ruled that no minority discount wouldapply because the family unit continues to control the corporation.
Now the IRS position has changed. As long as a corporation has a single classof stock, other family owned shares no longer have to be lumped with the transferred shares in determining eligibility for a minority discount.
Continuing the above example, the value of the stock you give your sons and daughter would be discounted because it represents minority interests in your company. So you would be able to give each child more shares eachyear without exceeding your gift tax annual exclusion limit.
The possibility of capital gains taxes can’t be ignored in considering a gift strategy. What if children sell the stock they receive as gifts? The giver’stax basis carries over to the children. With the same tax basis as the originalowner, the children may be liable for a substantial capital gains tax.
It works like this. Say you paid $200 a share for the transferred stock. Whenyou make your gift, the value is $500. At the time your child sells, the valuehas risen to $700 each. The taxable capital gain will be $500 a share ($700sale price, less your $200 basis).
What if instead you leave your stock to your children at your death? The capital gains situation will be much better. The stock’s tax basis will “stepup” to its value at your time of death. Your estate would contain the stockand, therefore, owe estate taxes on it. But your children would pay a lowercapital gains tax when they sell.
For example, your children inherit the stock from you. The stock is taxable inyour estate, and at your death it’s worth $760 a share. If a child later sellsthe shares for $800 each, the applicable capital gain would only be $40 a share.
It takes a very careful analysis of your particular situation to find the asset transfer approach that will be best. Frequently, that approach is to makelifetime gifts. Call your Financial Advisor today to obtain more informationabout transferring assets.
ALAN S. MOORE, who writes this column every Wednesday for L’Observateur,is a financial advisor of Legg Mason Wood Walker Inc., a diversified financialservices and securities brokerage firm that is a member of the New York Stock Exchange and SIPC.
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