Exiting a family business is not an easy task. If you choose to pass your company on to a family member, you will have to choose whether to sell the business or gift it. Unfavorable tax ramifications can result when trying to sell your company. As a consequence, many family enterprises choose to gift their business to other family members.
When is the right time to gift the family business?
You can choose to gift the business when you die by leaving shares of the company in your will. This strategy is beneficial for income tax reasons. Your successors can buy the company stock at its fair market value, and avoid paying income tax on any (sizeable) profits. But unfortunately the inherited shares would not be without estate taxes. Any transferred shares are considered part of the deceased owner's taxable wealth.
You could also choose to exit the company while you are still alive. In using this approach, you would be able to relinquish ownership in stages, and therefore allow your successors to learn the business gradually. You would also reduce your estate taxes.
Lifetime gifting transfers the value of any future gains in the business out of the estate to your family. This is especially advantageous when business growth is expected. Gifts of up to $13,000 per recipient are tax-exempt in conformance to the annual gift tax exclusion. Total gifts in excess of $5,120,000 (2012 number) are free of taxes under your lifetime exemption. Partial interest gifts may be valued at a discount due to lack of marketability or restrictions on transfers.
Gifting your business using trusts
Your company can distribute gifts outright or in a trust. You could perhaps put together a trust that allows you to retain control of the business for as long as you wish. You can develop a revocable trust, which will avoid probate and allow you to terminate the contract at your will, or an irrevocable trust, such as a grantor retained annuity trust (GRAT), or a grantor retained unitrust (GRUT). These agreements can afford you income for a set amount of time, and transfer the business out of your estate at a discount.
The current low interest rate environment makes GRATS or GRUTS an attractive strategy for exiting your business. Both trusts include a fixed term, and they provide the owner ("grantor") an annual payout. This annuity usually involves a long term disbursement that is practically equal to the original worth of the assets that are in the trust. So as the trust term ends, any profits that are left over from the annuity distributions are typically free of gift or estate taxes.
If the funds you receive are a preset amount and do not fluctuate yearly, it is considered a GRAT. If the income is a percentage of the trust assets and the income fluctuates annually, then it is considered a GRUT. These trusts can be useful in helping you save on estate taxes, since they allow you to transfer your family establishment along with any future profits to your successors at a reduces amount, especially if you want (or need) the funds.
Gifting your company with a family limited partnership
A family limited partnership (FLP) is another entity you can use to transfer your business to other family members. It involves establishing a limited partnership that is used to operate and manage your family enterprise. You (along with your spouse) can be general partners, retain control of the business, receive revenue, and have your children assigned as limited partners. By disbursing yearly gifts to the limited partners, you may be entitled to valuation discounts, which could significantly minimize the taxable value of the company by giving annual gifts to the limited partners.
You must understand that using trusts, bequests, or family limited partnerships are only some of the many tax-saving methods for transferring family business worth to succeeding generations. Although these options may be particularly desirable in this present economy, it is still recommended to consult with your legal and financial advisors about other options.
When is the right time to gift the family business?
You can choose to gift the business when you die by leaving shares of the company in your will. This strategy is beneficial for income tax reasons. Your successors can buy the company stock at its fair market value, and avoid paying income tax on any (sizeable) profits. But unfortunately the inherited shares would not be without estate taxes. Any transferred shares are considered part of the deceased owner's taxable wealth.
You could also choose to exit the company while you are still alive. In using this approach, you would be able to relinquish ownership in stages, and therefore allow your successors to learn the business gradually. You would also reduce your estate taxes.
Lifetime gifting transfers the value of any future gains in the business out of the estate to your family. This is especially advantageous when business growth is expected. Gifts of up to $13,000 per recipient are tax-exempt in conformance to the annual gift tax exclusion. Total gifts in excess of $5,120,000 (2012 number) are free of taxes under your lifetime exemption. Partial interest gifts may be valued at a discount due to lack of marketability or restrictions on transfers.
Gifting your business using trusts
Your company can distribute gifts outright or in a trust. You could perhaps put together a trust that allows you to retain control of the business for as long as you wish. You can develop a revocable trust, which will avoid probate and allow you to terminate the contract at your will, or an irrevocable trust, such as a grantor retained annuity trust (GRAT), or a grantor retained unitrust (GRUT). These agreements can afford you income for a set amount of time, and transfer the business out of your estate at a discount.
The current low interest rate environment makes GRATS or GRUTS an attractive strategy for exiting your business. Both trusts include a fixed term, and they provide the owner ("grantor") an annual payout. This annuity usually involves a long term disbursement that is practically equal to the original worth of the assets that are in the trust. So as the trust term ends, any profits that are left over from the annuity distributions are typically free of gift or estate taxes.
If the funds you receive are a preset amount and do not fluctuate yearly, it is considered a GRAT. If the income is a percentage of the trust assets and the income fluctuates annually, then it is considered a GRUT. These trusts can be useful in helping you save on estate taxes, since they allow you to transfer your family establishment along with any future profits to your successors at a reduces amount, especially if you want (or need) the funds.
Gifting your company with a family limited partnership
A family limited partnership (FLP) is another entity you can use to transfer your business to other family members. It involves establishing a limited partnership that is used to operate and manage your family enterprise. You (along with your spouse) can be general partners, retain control of the business, receive revenue, and have your children assigned as limited partners. By disbursing yearly gifts to the limited partners, you may be entitled to valuation discounts, which could significantly minimize the taxable value of the company by giving annual gifts to the limited partners.
You must understand that using trusts, bequests, or family limited partnerships are only some of the many tax-saving methods for transferring family business worth to succeeding generations. Although these options may be particularly desirable in this present economy, it is still recommended to consult with your legal and financial advisors about other options.
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