Matters Column

Two tax areas to watch if considering transfer of business

February 17, 2017
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Thinking about transferring your family business interests or other assets this year? There are two major issues lurking on the tax landscape that you need to keep in mind: the future of section 2704 regulations of the internal revenue code and possible changes to the estate tax.

Prior to the presidential election, the IRS proposed regulations that would make the transfer of business interests between family members less favorable for tax purposes. The intent was to limit the two valuation discounts now available — lack of marketability and minority interest — that would apply when selling or transferring stock in a family business-related transaction.

Families historically have taken advantage of these valuation discounts, which recognize that closely held businesses have no public market for their stock and interests transferred generally do not have voting control and, so, deserve discounts. Combined, these discounts typically reduce the value of the business interests transferred by 25 percent to 45 percent.

In December, a public hearing on the IRS plans to limit the discounts raised issues — a lot of them. In fact, the IRS announced the proposed changes were not meant to be as broadly applied as people were interpreting them. In combination with the new president and Congress, they are far less likely to be implemented as drafted. This is good news for family business owners, as the regulations do not apply until finalized and, for now, remain as proposals only.

The second area that could face sweeping changes this year is the estate tax. As it stands, an individual now can pass up to $5.49 million of assets during life or at death without any estate tax. President Donald Trump indicated he would support a full repeal of the estate tax and generation skipping tax (GST) in favor of imposing a capital gain tax on the difference between the tax cost and the fair market value of any asset. 

Of course, only 0.2 percent of all estates are subject to estate tax, according to the Tax Policy Center. But uncertainty exists over what could happen — complete repeal with no replacement or some form of capital gains based tax. While the estate tax is not favored by the president or Congress, there are concerns about how that revenue would be replaced and the pressures of balancing the budget. 

Five considerations for 2017

While we will know a lot more about this administration’s intentions in the next six months, there are a few considerations you will want to keep in mind as you plan to gift or sell family business interests or other assets early this year:

  • Annual exclusion gifting: If you have sufficient assets, there is no reason to change the annual exclusion gifting of up to $14,000 per year per person to transfer family business assets. Annual exclusion gifts are use it or lose it; gifting will not count against the estate tax exemption limit. 
  • Gift tax exemption: Be careful of making gifts of more than the remaining amount of your gift tax exemption. This has been true for several years but bears repeating. Wealth planners would not recommend gifting family business interests that would exceed your remaining exemption and triggers gift tax to be paid. If the estate and gift taxes are repealed, you may have paid a tax you otherwise would not have paid.
  • Formula clauses: In the event of repeal of the estate tax, be sure to review formula clauses in your estate plans to ensure the distributions would be as expected. For example, if the amount going to a generation or dynasty type trust was capped at the maximum amount of GST tax exemption available and there is no GST tax, how much would be transferred into that trust vs. what would be distributed outright?  Is there a default percentage or fixed dollar amount that would apply? 
  • Income and capital gain tax planning: Continue to review the built-in gains in assets when evaluating transfers. Assets in an estate at someone’s death get a step-up in basis, and under the current taxes, it may be beneficial to gift assets with minimal built-in gain. If the tax is changed to be based upon capital gains, it may be beneficial to gift assets with more gain, particularly interests in a family business where no long-term sale is intended.
  • Keep in touch: With pending changes to the 2704 regulations and possible changes to the estate tax law, you will need to keep in touch with your planning professionals. Furthermore, if you feel the discussions with them are getting more complicated, it is because they are — there are more variables than ever when considering how to best transfer family business interests. If updating your estate plan, make sure your documents address the possible repeal of the estate tax.

Attorney Mark Periard is the director of wealth management at Legacy Trust, an independent, locally owned Michigan-chartered bank that works with family business owners. He can be reached at mperiard@legacygr.com.

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