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Now s the time to start thinking about an ownership transfer

August 20, 2012


As proud as you are of your construction company, at some point you’ll likely want to exit the business. If you wish to transfer ownership to the next generation (rather than sell to a third party), starting such transfers sooner rather than later can be a smart move tax-wise — especially this year.Maximize your exemption

If you’re ready to transfer ownership interests in your business, now may be the time. The 2012 federal gift tax exemption is $5.12 million, but it’s scheduled to drop to $1 million in 2013. This means that you (and your spouse if married), can each gift up to $5.12 million to your heirs without incurring gift tax. Any appreciation in the shares will be growing in your heir’s estates instead of yours which will further save taxes.

By gifting interests now, you can potentially lock in the currently high exemption, plus keep future appreciation out of your taxable estate. (Keep in mind, however, that any gift tax exemption used during your life will reduce your estate tax exemption dollar for dollar.)

To further leverage the amount of your gift tax exemption is the use of valuation discounts to drive down the value of the shares being transferred to allow for more shares to be transferred.  The two popular discounts are Minority interest discounts and lack-of-marketability discounts. If you retain control of the company, you can generally transfer shares to your heirs and reduce the value of those shares by a minority interest discount. This makes sense because most people wouldn’t pay full value for something that they can’t control. The lack-of-marketability discount is available if you have a buy-sell  or close-corporation agreement that restricts the availability to sell the shares to anyone they wish. This makes sense because you can’t readily convert these shares to cash as you could with a publicly traded stock. These discounts can range in the 20-40% valuation range. A qualified appraiser will be needed to determine the fair market value of the company and fully document the reasoning behind the discounts.

Leverage annual exclusions

You can transfer ownership over time by systematically gifting interests equal to the annual gift tax exclusion (currently $13,000 per recipient) each year. Even though such gifts are tax-free, they don’t count toward your gift tax exemption.

So you can use your annual exclusions to make tax-free gifts in excess of your gift tax exemption or to preserve your exemption for future use.

Situation One – If you want to maintain operational control, but you don’t need to gift more than 50% of the value of your business, a straight gift of shares will work.  You can still utilize the discounting methods above to leverage the gifts.

Situation Two -The most common situation we encounter is where the business owner doesn’t want to relinquish operational control, yet still needs to gift away more than 50% of the value of their business. There are a few techniques we will describe below that will accomplish this goal.

Recapitalize your company

This technique involves dividing your company’s ownership into voting and non-voting shares. You can retain the voting shares, and gift the non-voting shares to your heirs. As discussed above the valuation discounts would apply to the gifts of non-voting shares. This technique can be used for either C-corp or S-corp shares.

Form an FLP

If you’d like to transfer more than 50% of ownership yet remain in operational control, consider a family limited partnership (FLP). You can gift limited partnership interests to your heirs (immediately or over time, applying your gift tax exemption or exclusions and valuation discounts as appropriate) but retain a general partnership interest and continue to control day-to-day operations. This technique will not work for S-corporation stock as a partnership is not an eligible shareholder.

Be advised: The IRS often challenges the validity of FLPs. It’s important to structure and operate yours in a way that will pass muster.

Sale to an Intentionally Defective Grantor Trust (IDGT)

This is a more complicated freeze strategy that could be utilized with larger gifts. This strategy involves selling your shares to a trust in exchange for a promissory note. The benefit to this strategy is that all of the appreciation (over the note’s interest rate) is transferred to the heirs, but the grantor continues to pay the income tax on the earnings of all of the shares. Thus, the trust allows for the shares to be removed from your estate, but due to the “intentionally defective” structure of the trust, you are treated as owing the shares for income tax purposes. Although this may not sound like an advantage, it allows for further leverage of the gift by the grantor removing the income tax out of his estate.

Grantor Retained Annuity Trust (GRAT)

Transfers of shares to a GRAT in exchange for an annuity is another technique that can be utilized. Similar to the IDGT described above, this is a freeze strategy that can transfer the appreciation above the built in IRS applicable federal interest rate. Currently these rates are at historic lows and can allow for a larger transfer while utilizing very little gift tax exemption.

Get started

These methods are a good place to get started thinking about how to take advantage of your gift tax exemption and exclusions to transfer ownership of your business to your heirs.  Work with your advisor’s to pinpoint the best way to put the construction company you’ve worked so hard to build safely in the hands of your chosen successors.

Larry Powell can be reached at [email protected].

All content provided in this article is for informational purposes only. Matters discussed in this article are subject to change. For up-to-date information on this subject please contact a Clark Schaefer Hackett professional. Clark Schaefer Hackett will not be held responsible for any claim, loss, damage or inconvenience caused as a result of any information within these pages or any information accessed through this site.


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