Don't miss the window of opportunity...
Current tax and interest rate environments are uniquely favorable to business owners seeking to transfer a closely held business to the next generation. For many business owners, the company is a significant family asset. Unfortunately, the transfer of such a business to family members can trigger substantial estate or gift tax obligations, potentially requiring the sale of the business to satisfy the taxes. However, estate and gift tax laws applicable for the remainder of 2012 create opportunities to minimize this exposure.
The Tax Relief, Unemployment Insurance Reauthorization and Job Creation Act of 2010 (the “2010 Tax Act”) made favorable changes to the federal estate and gift tax laws. These changes will expire on Dec. 31, unless Congress takes additional action. The 2010 Tax Act provides opportunities for business owners to transfer assets to the next generation, while minimizing tax liabilities. In addition, applicable federal interest rates are at record lows and can also be utilized to transfer business interests in a tax-efficient manner.
Transfer Tax Changes
The 2010 Tax Act lowered estate, gift and generation-skipping transfer tax (collectively, “transfer tax”) rates and substantially increased the relevant exemption amounts. The “exemption amount” is the amount an individual can transfer during his or her lifetime or at death without paying a transfer tax. The tax rates and exemptions available under current law are as follows:
Estate/Gift Tax Exemption Amount
Highest Estate/Gift Tax Rate
* plus inflation adjustment (indexed from 2010)
Because favorable provisions in the 2010 Tax Act expire at the end of this year, there is a short window to maximize use of its provisions to implement business succession planning. Potential opportunities include:
Gifting. With the current exemptions, gifts can be made to heirs (either outright or in trust) without incurring any out of pocket taxes. A couple could potentially give as much as $10 million to their heirs without paying transfer taxes. For some businesses, this could allow business owners to transfer a large portion of their company to the next generation.
Sale to Family Members. In addition, business owners may wish to sell interests in their company to members of the next generation in exchange for a promissory note. Because the applicable federal interest rates are currently at record lows (the midterm rate for February 2012 is 1.12 percent), this can be a very efficient strategy to begin shifting ownership to the business owner’s heirs.
Sale to Trust for Family Members. Finally, a business owner could sell interests in his or her business to a trust established for family members also in exchange for a promissory note. The trust can be structured to avoid the recognition of capital gain on the sale for income tax purposes. Such a trust could also be designed to shelter the family business from estate tax for many generations.
Consider Your Options
The 2010 Tax Act includes provisions that can be advantageous in planning for your family business. You may wish to consider taking advantage of the potential opportunities while they are available. Because the tax laws are complex and change frequently, it is important to review your individual situation with a tax advisor.