Now is the Time to Gift! Gifts and Pre-Retirement Planning

Back to Articles Page

The current status of the economy is such that many business owners approaching retirement age are reluctant to discuss or consider estate planning, and have no plans to transfer any portion of their business to their children.  In fact, this economy has presented a golden opportunity to dispense part of a business equity interest, retain full control of business operations and achieve one of the steps in estate planning with a minimal effect on losing lifetime gifts excludible from any gift taxes.

To take advantage of this opportunity, one must first quantify the gift with the objective of gifting the highest equity without losing control, at the lowest fair market value.

To ascertain the fair market value of a potential equity interest gift in a business requires a valuation of the business.  If the business is closely owned, and a gift is for a minority equity interest, the value of the gift can be reduced for both a discount for lack of marketability and a discount for minority (or non-controlling) interest.

With the market value of a business dependent upon the effects of the declining economy, coupled with an increase in the above discounts due to a decrease in potential buyers, the fair market value of any minority (or non-controlling) interest is probably at its lowest level in many years.

Gift Taxes

This article is not intended to explain the complexities of the tax rules that follow.  One should contact a WISS Tax Expert for such information.

This article is presented to help complying with the tax rules, but be able to take advantage of the economy’s problems, avoid gift taxes, reduce future estate taxes, and still preserve a family’s wealth without losing business control.

Overview of Federal Gift Tax Provisions

• The gift tax is imposed on the transfer of money or other property by gift.
• Gifts made by an individual, in a tax year, of a present interest with a value of $13,000 in 2009 or less, to any one individual, are not subject to tax.
• The gift tax is usually payable by the donor (giver) and not the done (receiver).
• Gifts in excess of the annual exclusion, totaling $1,000,000 during a person’s lifetime, are exempt from any gift taxes.

Practical Examples of Savings

An example of the savings that can be realized by gifting (instead of paying estate taxes upon death) follows:

An individual with 100 family members and friends elects to gift $12,000 to each in 2008 (a total of $1,200,000) without the requirement of filing a gift tax return and paying any applicable gift taxes.  In addition, the $1,200,000 would be excluded form his estate upon death.  If the $1,200,000 was not gifted, a federal estate tax of possibly $540,000 would be payable by his estate upon death.

How Does One Make a Gift?

A business owner should find a certified business appraiser, with business valuation credentials such as an ASA, CVA or a CPA/ABV, who can determine the fair market value of the business equity interest to be gifted.  The above designations are recognized business valuation credentials that are especially important for valuations that are submitted to the IRS. (The valuation report is attached to the “United States Gift and Generation Skipping Transfer Tax Return, Form 709”).    

The appraisal process typically includes a meeting with the equity owners and outlining the scope and fee of the valuation.  The business appraiser prepares a document information request and once the information requested is received from the equity owners, the actual valuation process usually takes 4 to 6 weeks.  The fee depends on the type of valuation of equity interest in a family limited partnership (that owns principally marketable securities or real estate). Expect higher fees for a detailed appraisal of a closely held business. 

Discounts for Minority (or Non-Controlling) Interest and Lack of Marketabilty

A gift of a minority equity interest in a business typically would require a discount for minority interest, as the pro-rata share of a minority interest in a business is actually worth less than a mathematical pro rata amount as the minority equity owners does not have any control of the business.  Accordingly, an appropriate discount for minority interest is applied. 

A closely-held business or closely-held business interest is not readily marketable as cash or a marketable security that can be converted into cash in three days.  Accordingly, a discount for lack of marketability is necessary to reflect the illiquidity of the minority interest and the time it would take to convert it into cash. 

For example, a business owner intends to gift a 20% minority interest in his business to his children.  First, the total value of the business is obtained.  Then, the pro rata amount of the gift (20%) is applied to the total value.  Lastly, potentially two additional discounts lowering the value would be applied (i.e. discount for minority interest and discount for lack of marketability).  

Conclusion

As the economy is currently in a recession, and market multiples are low, and discount rates reflecting risk are high (implying lower values), the resulting equity values for gift tax purposes indicate gifting is extremely beneficial to a business owner approaching retirement age.  If the business owner has the ability and desire to gift, now is the time.   

The advantages of making a gift is the reduction in future estate taxes, moving wealth to children and maintaining continuity of the business, and, as part of the business income will be taxable to the children, a reduction in cumulative income tax.

By: Monica Kaden, MBA, ASA
Manager, Business Valuation and Litigation Support
WISS & Co, LLP
Contact number: 973-994-9400