By Terry Silver
Special to the Legal
The Internal Revenue Code allows an individual making a gift (referred to as a donor) to utilize a lifetime gift tax exclusion. Owners of businesses often wish to pass assets via gifting to children and grandchildren. This is partially or totally accomplished by the use of an individual’s lifetime allowable gift exemption, currently set at $5.25 million (indexed for inflation annually). For indirect or direct skips to grandchildren, a donor also may want to allocate the current available lifetime exemption for generation-skipping tax, also currently $5.25 million (indexed for inflation). For a more detailed description of gift taxation, consult your tax adviser.
A business owner may take advantage of the lifetime gift tax exemption by gifting an interest in his or her closely held business enterprise to a family member. Typically, if a minority, nonmarketable interest of a business is gifted, valuation discounts can be computed, which will increase the amount being gifted from generation to generation. This often can be accomplished while still avoiding the payment of gift tax by staying below the exemption levels of $5.25 million.
A significant advantage of pre-death gifting is the anticipation of the asset’s growth in value from the gift date to the donor’s death date, thus transferring the asset’s appreciation to the donee (younger generations).
Following is a case study:
A privately owned company is equally owned by two individuals via traditional voting stock. The company recapitalizes its equity via the creation of nonvoting stock, which in our case study composes 80 percent of the total equity. An original, 62-year-old shareholder gifts 60 percent of his nonvoting stock to his 35-year-old daughter; the amount represents 24 percent of the outstanding equity of the company. The company had an estimated value of $8 million, pursuant to the business valuation as of the date of the gift. Since the gift represented a minority interest, a discount for lack of control of 25 percent might be utilized. Assume further that the valuation analyst determined this ownership block was not readily marketable, so an additional 20 percent discount for lack of marketability might be utilized. It is even further possible that the analyst might consider an additional 3 percent discount for lack of voting.
In this case study, the resulting estimated value of the 24 percent noncontrolling, nonmarketable, nonvoting interest was $1.1 million. This compares to the intrinsic or nondiscounted estimated value of $1.9 million. Thus, in our case study, the donor transferred $1.9 million of value via a gift of $1.1 million, which represents just a portion of the donor’s lifetime exemption of $5.25 million. Of course, valuation discounts are not always as shown in this case study, and are determined by the valuation analyst based on the specific facts and circumstances of the particular company being valued.
In summary, business owners can utilize discounting to economically transfer company interests to their children and grandchildren during their lifetime. In addition, the donor can transfer the asset’s appreciation to subsequent generations, while still maintaining control over the asset during their lifetime.
A partner in Citrin Cooperman’s Philadelphia office, Terry Silver’s specialties include business valuation services and forensic accounting, testifying as an expert witness in Pennsylvania and New Jersey courts. He is accredited in business valuation through the NACVA and in forensic accounting through the AICPA.
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