The end of 2020 brought a flurry of gifts by individuals who were looking to take advantage of estate planning techniques by gifting privately-held equity interests in their family-owned businesses. If you did not have the opportunity to perform estate planning in 2020, it is not too late, and here is what you need to know.
Why gift equity in a family-owned business in the first place?
Assets that remain within an estate are subject to a federal estate tax, which can be as high as 40 percent. This also applies to a private company ownership interest held by an estate. An efficient way to reduce or even eliminate federal estate taxes is gifting the interest years in advance.
Why is gifting family-owned stock tax efficient?
There are three primary reasons why it is tax efficient:
- Appreciation: It is generally a safe assumption that privately-held stock will appreciate over time. So if there is future intention to transfer ownership, by gifting the stock now you are locking in the value of the gift before future appreciation. Otherwise, the appreciated value at the date of death will be charged against the estate.
- Discounts: It is well established that privately-held ownership interests are subject to two types of discounts: (1) discount for lack of control and (2) discount for lack of marketability. These two discounts combined can reduce the value of the gift by approximately 30 percent below the actual “full” value of the equity interest.
- Lower Valuation: Valuations that are used for estate planning purposes are generally on the lower end of the “valuation scale.” This concept is best highlighted when a business is sold several years down the road. Upon the sale, the value of the entity will be known via the transaction price, and will most likely be on the higher end of the “valuation scale.” If a gift (or estate transfer) is executed after a sale transaction, a significantly greater portion of the estate tax exemption will be used up.
What is the federal estate tax exemption?
Gifts in excess of the annual gifting limits ($15,000 per person) begin to eat away at the lifetime gift and estate tax credit. For 2021, each individual has an $11,700,000 federal gift and estate tax exemption. Cumulative gifts and estates that exceed the exemption are then subject to a federal estate tax, which can be as high as 40 percent.
So why gift privately-held stock now?
The federal gift and estate tax exemption was essentially doubled in 2017 with the passage of the Tax Cuts and Jobs Act. The doubling of the exemption is set to sunset at the end of 2025. However, the current administration has proposed changes to the “wealth” taxes, which include accelerating the sunset provisions, and possibly reducing the exemption to as low as $3,500,000. Any reduction to the federal gift and estate tax is subject to Congress passing a tax law change, but there are rumors that this could happen as early as the beginning of 2022.
Only time will tell when an actual tax law change may take effect, but tax law changes aside, it is never too soon to start estate planning. If transferring wealth is something you’re interested in, it is never too early to start the conversation and get the wheels in motion on executing a gift. As always, if there is anything Kreischer Miller can do to assist you with your planning needs, please do not hesitate to reach out.
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