How Family Businesses Can Prepare Now for Future Tax Changes

The upcoming presidential election is giving small to mid-sized business owners concerns regarding changes in their business and the legacy they leave to family members. The recent article “How family businesses can come out on top in presidential election uncertainty,” from the St. Louis Business Journal looks at what’s at stake.

Tax breaks. The current estate tax threshold of $11.58 million is scheduled to sunset at the end of 2025, when it will revert to the pre-2018 exemption level of $5 million (as indexed for inflation) for individuals. If that law is changed after the election, it’s possible that the exemption could be phased out before the current levels end.

Increased tax liability. These possible changes present a problem for business owners. Making gifts now can use the full exemption, but future gifts may not enjoy such a generous tax exemption. Some transfers, if the exemption changes, could be subject to gift taxes as high as 40%.

Missed opportunity with lower valuations. Properly structured gifts to family members, which benefit from lower valuations (that is, before value appreciation due to capital gains) and current allowable valuation discounts give families an opportunity to pass a great amount of their businesses to heirs tax free.

Here’s what this might look like: a family business owner gifts $1 million in the business to one heir, but at the time of the owner’s passing, that share appreciates to $10 million. Because the gift was made early, the business owner only uses up $1 million of the estate tax exemption. That’s a $9 million savings at 40%; saving the estate from paying $3.6 million in taxes. If the laws change, that’s a costly missed opportunity.

It’s better to protect a business from the “Three D’s”—death, divorce, disability or a serious health issue, by preparing in advance. That means the appropriate estate protection, prepared with the help of an estate planning attorney who understands the needs of business owners.

Consider reorganizing the business. If you own an S-corporation, you know how complicated estate planning can be. One strategy is to reorganize your business, so you have both voting and non-voting shares. Gifting non-voting shares might provide some relief to business owners, who are not yet ready to give up complete control of their business.

Preparing for future ownership alternatives. What kind of planning will offer the most flexibility for future cash flow and, if necessary, being able to use principal? Grantor Retained Annuity Trusts (GRATs), entity freezes, and sales are three ways the owner might retain access to cash flow, while transferring future appreciation of assets out of the estate.

Know your gifting options. Your estate planning attorney will help determine what gifting scenario may work best. Some business owners establish irrevocable trusts, providing asset protection for the family and allowing the trust to have control of distributions.

Reference: St. Louis Business Journal (April 3, 2020) “How family businesses can come out on top in presidential election uncertainty”

 

Good News About Gifts

It’s worthwhile to understand the rules about taxes that might be triggered by your generosity, says Forbes in the article “How To Avoid Taxes When Giving Big-Dollar Gifts.” Did you know that you can give any one person as much as $15,000 every year, without having to pay any gift taxes? You can give any number of people up to $15,000 and they don’t even need to be relatives.

Note that if and when any gift taxes are due, it’s the giver who pays any gift taxes, and not the recipient.

Therefore, if you think the world of your next-door neighbor and give him a gift of $20,000, you only owe taxes on the $5,000 above the $15,000 limit, and that’s also if your total gift exceeds your lifetime exclusion. You don’t have to be generous with cash only. Gifts can come in the form of stock, a boat or jewelry. Just remember to keep it under $15,000, so as not to incur any gift taxes.

The $15,000 limit is per person, not per couple, so if you want to give someone $15,000 and your spouse also wants to give them a $15,000 gift, that works. You can double the gift, while still staying under the annual limit.

If your gift is going to a charitable organization—a registered 501(c)(3), you won’t owe anything in gift taxes.

In addition to this $15,000 annual cap, wealthy gift givers should just keep in mind a $11.4 million maximum that is known as the lifetime exclusion. That’s the limit in 2019, and it will rise next year. This governs all the gifting you do during your lifetime. That’s outside of the annual exclusion of $15,000.

Anything more than that in the way of gifts, and you or your estate will have to pay estate tax. The top rate for the overage is high-40%. However, you’ll have to be mighty generous to get near that limit.

Here’s what’s nice: you won’t have to pay gift taxes every single time you go over that $15,000 limit. Let’s say you give your son $50,000 in 2019. Your gift is $35,000 above the ceiling, which is taxable.  However, rather than write a check for taxes to the IRS now, you count it against the $11.4 million lifetime exclusion. You now have $11.365 remaining.

The best way to go about gifting, is to make sure that your desired gifts are working in concert with your estate plan. One reason for gifting “with warm hands” is to reduce the taxable size of the estate, but there are many other ways to do this. There are also instances when gifts need to be reported to the IRS, even if no taxes are owed on them.

Speak with an experienced estate planning attorney about your gifting strategy, how it works with your estate plan and what gift tax forms you do, or do not, need to file.

Reference: Forbes (October 14, 2019) “How To Avoid Taxes When Giving Big-Dollar Gifts”