PASSING ASSETS TO FAMILY
Many years ago it was possible to pass business assets to family members
with little gift tax involved. However, Congress viewed this as an attempt
to avoid tax on current assets (true) and instituted various rule and laws
so that a gift of a business interest would be currently valued for estate
tax purposes. In other words, if the value was over $10,000, the individual
would need to file a report for the amount and subsequently use up his/her
$650,000 lifetime exemption. Amounts over that were subject to gift tax.
Obviously estate and business planners worked to find methods of reducing at least part of the exposure. The following are current methods.
Assume an owner, age 60, had a business worth $1,000,000.
She gives her daughter $200,000 of common stock (gift taxes would apply to
$190,000) and retains $800,000 of preferred. The owner MUST receive dividends
on the preferred but at her death only the $800,000 will be included in her
estate. This allows all subsequent appreciation (say the business is now
worth $4,000,000) to be included in the daughter's assets. The payments of
dividends on the preferred- taxable- shows that the stock has value and was
not a sham transaction done simply to avoid taxes. There are still areas
of concern- the initial transfer must have a realistic value, preferably
by formal appraisal, and the mother would have to pay gift taxes on the $190,000
transfer. But it is a method of reducing exposure to future appreciation
Another method receiving considerable attention is the family partnership. Mom and Dad can be the general partners and the children as limited partners. Gifting of partial interests (again say $10,000) would not incur current tax and the general partners maintain control of the asset.
A family partnership can:
1. Transfer assets to children
2. Freeze value of the estates by transferring future appreciation
3. Retain control over assets
4. Lower estate-tax values through control and marketability discounts
5. Shift taxable income to lower bracket family members
The parents can set up a limited partnership giving children limited partner interests- which have full transferability and limited liability- while they retain the general partnership interests. The parents can gift $10,000 each of shares each year without any gift tax. Any appreciation in these interests is no longer in the grantor's estate. The family partnership also can cut estate taxes on the various interests through valuation discounts since a minority interest is worth less than a controlling one. Further, an interest that is nor readily marketable (family business) is worth less than a marketable interest. (In actuality, it's possible to gift $14,285 if the minority discount, etc. equaled 30%.) But all the p's and q's must be followed- written agreement, partner's meetings, filing of partnership taxes for everyone, arm's length valuation of interests, etc. Unfortunately, the capital of the business must be materially INCOME producing and therefore most personal service business will not qualify.
Lastly, if a family member purchases an interest from another family member, the transfer will be a gift of the share's fair market value.
This is all very simplified for this commentary. One major drawback that is not addressed in many articles is the fact that once the property is given away, it becomes the sole ownership of the child/owner. If they decide to leave the business, are involved in a divorce or other similar complication, go through bankruptcy, etc. the owner can end up trying/having to buy back the interest, having other owners involved and so forth that were never contemplated. Like a lot of planning issues, they can look fine "on paper" but can get screwed up quickly when put into actual practice.
An owner might put the limited partnership interests for the children into a trust, but I think you'd probably still need a post nuptial agreement. It might be worthwhile for owners/parents to do full background checks on their children before ever considering a transfer. Admittedly it is rare that this would happen, but after seeing a couple of these really go sour, I bet the parents would have spent any amount of money to avoid their current problems.