Successful business owners are eventually faced with the challenge of passing on their business. There are many options, in fact, it may seem that there are too many options. The business could be sold to a competitor. It could be sold to a junior employee. It could be sold to all or most employees with an employee stock ownership plan. It could be passed on to some or all of the owner’s children. An owner might sell his or her interest in the business to existing partners. Or the owner might just sell off all the assets that can be sold and shut the doors.
Ideally, an owner will start planning early with the assistance of the company attorney, accountant, and insurance agent. The costs, expenses, benefits, and drawbacks of each option will be put on a spreadsheet and carefully analyzed. It can easily take a year to do this kind of planning, and it might take several years to execute the plan.
For example, a commonly used plan involves gifting small percentages of a company entity to a child over several years. During that time, the child gains knowledge and experience and is given more responsibility. Eventually (if all goes as hoped) the parent is ready to let go and give the child a majority share of equity and primary responsibility for management.
A significant consideration in this kind of plan is the valuation of the percentages gifted to the child, and the tax consequences of such gifts. If a company is worth $20 million, and in Year 1 of the plan the parent gives the child a 2% interest in the company, the value of that gift is $400,000. Because $400,000 is greater than the federal annual gift exemption amount of $15,000, the gift must be reported to the IRS on form 709. If similar gifts are given in subsequent years, the value of the gifts may come to total several million dollars. This could trigger the federal unified estate and gift tax.
In 2022, a person can make lifetime gifts of $12.06 million without triggering the federal unified estate and gift tax (twice that for married couples filing jointly). However, this amount will be reduced to $6.2 million at the end of 2025 unless Congress acts to extend or modify it.
What is certain is that changes are coming, and the next few weeks present a last opportunity for business owners to make substantial gifts under the existing generous threshold. If you have been considering passing on your business, now is the time to consult with your professional advisors.
This is not intended to be legal advise. You should contact your attorney to discuss your specific situation.
This article appeared in the August 16, 2022 edition of the Sullivan County Partnership’s In the Know Magazine.