New limited time offer5 million gift and estate exemption

November 14, 2011
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A limited window of opportunity exists to transfer significant portions of your family business.

For 2011, the amount of assets you may transfer to a family member gift tax free is $5 million. This assumes you have not previously used any portion of your gift tax exemption. The amount will be adjusted for inflation in 2012 (estimated to be $5,120,000). Because the exemption applies on an individual basis, a married couple can transfer a total of $10 million in assets gift tax free. Once your exemption is fully used, the tax rate applicable to additional transfers is 35 percent.

Unfortunately, these exemption and rates are only effective through the end of 2012. Absent legislative action, the exemption will revert to $1 million ($2 million for a married couple), and the tax rate will be 55 percent.

The same exemptions and rates also apply for estate tax; however, it is important to keep in mind that the exemption can only be applied either to gifts or to transfers from your estate, not both.

A relatively straightforward strategy that is often employed to reduce estate exposure involves annual gifts to family members. The tax law currently allows each individual (donor) to exclude the first $13,000 (indexed for inflation) of gifts to each recipient (donee) on an annual basis.

Many donors operate under the general rule of thumb that a gift tax return does not need to be filed if all of your gifts are within the annual exclusion amount. However, there are many circumstances that warrant filing a return. For example, if you wish to limit the period of time in which the Internal Revenue Service can audit your gifts, you must file a return and adequately disclose those gifts.

Another very important and often overlooked reason for filing a gift tax return may be the need to make the appropriate allocation of your $5 million Generation Skipping Transfer Tax Exemption and/or make a corresponding GSTT Election. While the effects of the GSTT may go unnoticed for many years, it can have a significant impact on the value of assets distributed to future generations, as those distributions could be subject to a tax rate of 35 percent (or higher).

For many business owners, transferring ownership slices of $13,000 per year may not be practical due to costs, the overall value of the business, the rate at which the business is appreciating, or the pace at which you desire to transfer ownership. Fortunately, the new increased exemption provides an opportunity — at least through the end of 2012 — to transfer a significant portion of your business without incurring gift tax.

Some business owners may be able to transfer the entire value of their business in a single gift. Others may choose to gift a portion and sell a portion in exchange for a note to help sustain their cash flow in retirement. For those with businesses valued in excess of $5 million to $10 million, the new exemption amount can provide a renewed opportunity to leverage a larger transfer of your business to specialized trusts.

While the increased exemption provides greater flexibility, bringing a plan to fruition involves analysis of many different aspects of your financial life as well as consideration of competing goals.

A typical concern of many exiting business owners is the adequacy of their personal cash flow in retirement years. This often results in a natural tension between the desire to transfer assets to family members and retaining sufficient sources of cash to meet lifestyle needs after retirement. Making sure these competing concerns are properly balanced typically involves “crunching the numbers.”

A multi-year analysis that takes into account the primary area of concerns including a balance sheet (current and future), cash flow projection, income tax projection and estate tax projection are all important aspects of a well crafted plan. The unique circumstances of your financial life should drive the composition of the analysis.

In addition to developing a financial plan, steps should be taken to address other succession matters. Again, each plan will vary depending on the unique circumstances surrounding your assets, but most should address the following items:

  • In the state of Michigan, most trust and estate lawyers agree that business owners should plan to avoid probate. Probate is an expensive public process that can cause delays in estate administration. To avoid probate, you should meet with an attorney for the drafting of a revocable living trust. Once you have signed the trust document, most of your property, including your business, will be transferred to the trust. In most cases, you will be the trustee of your trust. Other estate-planning documents will include a will and durable powers of attorney for assets and health care.

  • Many business owners fail to consider that they might be involved in an accident or experience a heath event that causes incapacity rather than death. Typically, through a public court process, a family member will be appointed to serve as conservator to manage your person and your property, including your business. Rather than leave this process to the whim of the probate courts, a well-drafted revocable living trust can consider your wishes on how the business assets should be managed both during your incapacity and at your death.

  • The liquidity costs to the business caused by the death of a business owner can be significant. One of the major costs is the estate tax. An estate tax projection should be prepared by your accountant, and the business owner should consider ways to pay the tax, including life insurance. If you have co-owners and the plan is to buy out a deceased owner’s interest, the funding of the purchase price must also be considered. A well-drafted buy/sell agreement is a must.

One of the most difficult tasks in succession planning is balancing your goals and objectives with respect to both the running of the business and a fair distribution of your estate. The estate owner should understand that while an equal distribution of the business assets among the heirs seems fair, the arrangement could most likely be disastrous to the future success of the business.

The new $5 million exemption spells greater opportunity for transferring your family business. But it is a limited time offer so you should plan to seek the advice of your accountant, estate lawyer and financial advisor to create a plan that addresses how this exemption is best used before the end of 2012.

Richard Noreen, tax partner, and Bruce Vandermeulen, tax senior director, are with BDO. Noreen can be contacted at 616-776-3698 and Vandermeulen at 616-802-3396. The views expressed are those of the authors and are not necessarily of BDO USA LLP. The comments are general in nature and not to be considered specific tax or accounting advice and cannot be relied upon for the purposes of avoiding penalties.

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