Eubel Brady & Suttman Asset Management, Inc

With President Biden and multiple Senators proposing revisions to tax laws, this may be the time to consider whether to take advantage of the current estate and lifetime gift tax exemption.  The estate and lifetime gift tax exemption for 2021 is $11.7 million per individual or $23.4 million per married couple. Absent a change in the tax law, this exemption is set to expire on December 31, 2025 and return to the prior $5.49 million per person. Proposals for revision of the tax law seek to reduce the lifetime gift and tax exemption well below this amount and increase the estate tax rate.  In this article we will briefly review options that may be employed to transfer a full or partial business interest to family members or heirs in an effort to take advantage of the current exemption.  At present, it is contemplated any downward revision in the exemption will not apply retroactively. 

Full or Partial Gift of Business Interest
When you make a gift of some or all of your business interest, the value of the gift as well as the future appreciation is removed from your estate, which could mean lower estate taxes that may be due at your death.  You may be subject to gift taxes on the gift, but you will have frozen its value, meaning you won’t be subject to tax on any future appreciation.  This can be a valuable strategy when you expect the value of the business to continue growing.  

You can give away a little or a lot of your business interest to whomever you choose. You can also control the timing of the gift.  Lifetime gifts of your business interest may allow you to relinquish control according to your own timetable, and they can be done privately if you so choose.  You might consider a systematic plan whereby you make small gifts of your business interest to one or more recipients each year over a period of time.  If the value of each individual gift is equal to or less than $15,000 per recipient in 2021, the gifts are federal gifts tax free under the annual gift tax exclusion. A married couple can split the gift and give an amount equal to double that amount, as long as both spouses are U.S. citizens and the gift is made jointly.

Grantor Retained Trust
A grantor retained trust is a type of irrevocable trust in which an individual (called the grantor) transfers assets into a trust and then retains an interest for a period of time.  The retained interest may be the right to receive annuity or unitrust payments or may be the right to use the property in the trust.  At the end of the retained interest, the property in the trust will pass to the beneficiaries of the trust. 

Commonly used grantor retained trusts include a Grantor Retained Annuity Trust (GRAT) or a Grantor Retained Unitrust (GRUT). The primary difference between a GRAT and a GRUT is whether the income payment to the Grantor is a set dollar amount or whether it fluctuates.

GRAT: an irrevocable trust into which you transfer assets (such as cash, stocks, bonds, and real estate) and then retain an annuity interest for a set period of time.  With a GRAT, the annuity payments you receive will be a fixed amount once a year or more often, if you desire.

GRUT: an irrevocable trust into which you transfer assets (such as cash, stocks, bonds, and real estate) and then retain a unitrust interest for a set period of time. With a GRUT, the unitrust payments you receive will be a fixed percentage of the value of the assets in the trust. The assets will then be revalued each year. Thus, if the value of the assets in the trust increases, the payments to you will increase as well. The payments from the trust may be made to you once a year or more often, if you desire.

The initial transfer of assets into the grantor retained trust is considered a taxable gift. However, grantor retained trusts are valuable estate planning tools because the value of the initial transfer into the trust may often be discounted for federal gift tax purposes.  The size of the discount will depend upon the length of the retained interest and the applicable federal interest rate that must be used to discount the gift.  The longer the retained interest, the more the gift can be discounted.  You can also use your applicable exclusion amount (formerly known as the unified credit) to protect some or all of the gift from the federal gift tax.  Furthermore, if the grantor outlives the term of the retained interest, then the assets, including any appreciation in the assets, is not included in his or her taxable estate.  Thus, transferring assets into a grantor retained trust can be an excellent way to remove assets (especially appreciating assets) from your estate while allowing you to receive a benefit from those assets for a certain period of time.  However, if you do not outlive the term of the retained interest, part or all of the assets in the trust at the time of your death will be included in your taxable estate.

Recent proposed tax law changes include limitations on grantor retained trusts. However, it is likely those limitations will not be retroactive and will apply to grantor retained trusts enacted after any change in the current tax law.

Recapitalization Through A Retained Interest
A retained interest involves a recapitalization of your business (in a tax-free reorganization) by dividing the common stock of the company into two classes of stock–voting and nonvoting stock. Once the two classes of stock have been created, you retain the voting stock and then gift away the nonvoting stock to your children and heirs. You can then maintain control of your company while gifting away some of the equity to your heirs. The gift to your heirs may qualify for the annual exclusion from the gift tax. You may also be able to discount the value of the gift because of the lack of marketability and the minority interest. By using the annual exclusion and the valuation discount, you can transfer a substantial amount of the nonvoting stock to your heirs without incurring a gift tax. The value of that stock, including any appreciation in that stock, will then not be included in your taxable estate.

Family Limited Partnership
A family limited partnership (FLP) is an entity formed to manage and control your jointly owned family business. There are requirements for a limited partnership that must be met.  Personal service businesses (e.g., lawyer, plumber, photographer) often don’t qualify.  Usually, the parents are named general partners, retain control of the business itself, and receive an income, while the children are limited partners.  By transferring the business to an FLP, the general partners (parents) may be able to use valuation discounts and substantially reduce the value of the business and perhaps any potential estate tax liability through annual gifts to the limited partner children.  The FLP is flexible and can be modified to meet changing family or business needs.

EBS is not an accounting or law firm and the foregoing is a general summary of the rules and limitations that may apply to you.  It is not intended to apply to all persons and situations and you should contact your tax or legal professional for advice.  Please contact a member of the Wealth Management Group to discuss your specific situation.

Data provided has been obtained by third party sources.  This data, while believed to be reliable, has not been independently verified by EBS.