Pre-Transaction Estate Planning Part 1: A Simple Gift Illustration

Especially in a time of very favorable interest rate environments, depressed asset values, a large estate/gift tax exemption, and capital gains rates that are probably as low as we will ever see them, pre-transaction planning is not an overly exciting blog topic, but it is an important thing for business owners to be aware of.  So here’s the first of a series of posts about some of the estate planning options you have as you prepare for a sale, liquidity event, retirement, or any kind of appreciation event this year.

By pre-transaction estate planning, I mean the estate planning opportunities that can capture the up-side of any appreciation or liquidity event and spread it among family at a low or zero transfer tax cost.  Transfer taxes are taxes levied on the transfer of assets to others, either during life or at death.  Currently we have a $5,120,000 exemption to use during life or at death before the person transferring the assets pays any tax.  Any gifts or transfers over that amount pay a 35% tax (substantially lower than the 45% or 55% tax in prior years). In Minnesota there is a $1,000,000 exemption at death, and no limit during life.  Combined with the low interest rates, low capital gains rates, lower business asset values, and exemption amounts that are set to expire at the end of 2012, this is a prime time to do any pre-transaction planning.

I will start with the most straightforward example: gifts to family members of business interests.  If you currently own 100% of a business entity, and are looking towards a sale in the next 2-5 years, you can use gifts of business interests to spread out the upside of that future sale.  For illustrative purposes, pretend you own 100 shares of the entity, currently appraised at $10,000 per share, or a total entity value of $1,000,000.  You consider this to be a very low valuation, and expect you could sell the entity for a higher price in a couple years.  You could transfer 1, 2, or even 5 shares to each of your grandchildren, in trust or outright.  If 4 grandchildren each own 5 shares, you still own 80% of the company, clearly retaining control.  The 5 shares are valued at $50,000, and because they are minority interests in the company and so are non-marketable business interests, could even be discounted further to $40,000 or $45,000 gifts.  The total gift is $160,000 to $180,000, barely using any of your allotted $5,120,000.  There is no tax due as a result of these gifts.  Fast forward 3 years, and you sell the company for $3,000,000 or $30,000 per share.  Now the grandchildren each have $150,000 and there is no additional gift implication.  The appreciation of $110,000 belongs completely to the grandchildren transfer tax-free. 

There are any number of variations to this example. You could create and gift non-voting shares, gift to dynasty trusts to last generations, or gift to a holding entity like a family limited partnership.  As this series progresses, I will discuss more leveraged gifts and how to use estate planning to make the sale of your business more appealing.