The time is right for gift planning for families in business
As June is the mid-year mark for gift planning, let's move beyond ties and books for dads and grads, and look at some extraordinary gift planning opportunities for families in business.
Due to lower interest rates and the decrease in value of most assets, families in business have unprecedented opportunities to shift some of their wealth this year. If it fits into your overall financial planning, before markets and property values rebound, and interest rates increase, now is the time to maximize current conditions to move assets to noncharitable beneficiaries. This can lower estate tax exposure and transfer assets to the next generation in a more accelerated manner. Also, in addition to taking advantage of current economic conditions, this is the year to focus on transfers to family beneficiaries before transfers among family members laws change.
The simplest way to take advantage of the current economic situation is to make sure to maximize the annual exclusion by gifting depreciated assets to your heirs, such family business company stock, or units in a real estate LLC. Currently, each taxpayer is allowed to give up to $13,000 of value to a recipient without incurring gift taxes; if your family business stock was worth $20 per share in 2008 and is now worth $15 per share, you can gift more shares now and, in effect, transfer more value while the stock price is depressed. (Be certain that you have valid appraisals to substantiate the value of the closely held stock and review any discounts applied to be sure they are not too generous.)
Be certain that the beneficiary of your gift becomes party to the shareholders' agreement and understands the responsibilities that come along with being a minority shareholder If you plan to gift shares in the family business to children who are not actively working in the family business, consider gifting them nonvoting stock, which may allow you to gift more shares, as the value of nonvoting stock is normally considered less than voting shares.
A bit more complicated transfer technique to consider is a Grantor Retained Annuity Trust ("GRAT"). A GRAT is a structured agreement requiring fixed payments to be made to the grantor/creator of the trust by the trust beneficiary over a fixed period of time. A parent creates a GRAT by transferring assets to an irrevocable trust for the benefit of one or more noncharitable beneficiaries and keeps/retains an annuity interest for a term of years. The value of the taxable gift is the difference between the fair market value of the transferred property and the value of the grantor's retained annuity interest. If the GRAT is set up so that the retained annuity's actuarial value is almost equal to the value of the property transferred, there is little gift tax consequences. If the grantor dies during the annuity period, the value of the remainder interest in the trust will be included in the grantor's estate. If, however, the grantor survives the term selected, the value remaining passes to the named beneficiary (ies) of the trust.
The annuity payments and their value are based upon a current interest rate set by the IRS. In April 2009, the "section 7520 rate" was 2.6 percent. In general, this means that the combination of all income generated from and the appreciation of the assets placed in the GRAT, which together exceed the 7520 rate, can pass without gift taxation and at the end of the annuity period, the asset is removed from the grantor/creator's taxable estate.
In light of current low interest rates and depressed asset values, these particular additional transfer techniques are best suited for this environment to discuss with your professional advisory team: sales to intentionally defective irrevocable trusts, self-canceling installment notes, and charitable lead annuity trusts.
Before you aggressively implement any gifting plan, be certain that your own financial future will not be compromised. For example, do not gift substantial shares of real estate to beneficiaries if the resulting reduced cash flow from your remaining interest will be insufficient for your household budget. By carefully analyzing which gifting technique is the most appropriate for you to implement you can transfer greater value now and perhaps save substantially on gift and estate taxes. However, be sure you understand how each strategy works, the cost to establish any transfer technique (appraisals, actuarial work, legal fees), and any income tax or estate tax consequences.
If you decide to implement any gifting strategies, be sure to watch how the recipients behave with the gift. Were they thankful? Do they understand the stewardship that accompanies the gift? How are they using what you gave them? If you see foolish financial behavior, you have the ability to change your estate planning documents or change future gifting plans. Heed the advice of Carrie Schwab Pomerantz, president of the Charles Schwab Foundation: "Live frugally and save for a rainy day." "Saving for rainy day is in my DNA;" "Live off 90 percent of your income;" "Save the other 10 percent, first as a cash cushion. When you're young, you don't need all of the bells and whistles in life."
Eddy, CFP, is president of San Diego-based Creative Capital Management Inc. and co-founder of the Family Business Forum at USD. She can be reached at peggy.eddy@sddt.com. Comments may be published as Letters to the Editor.
