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Gifting Shares of Stock in a Closely Held Business

Why now is a good time for tax advisers to explore with owners a chance to minimize estate and gift taxes by gifting shares to younger family members involved in the business.

September 2009
by Steven Fromm/Journal of Accountancy

Why now is a good time for tax advisers to explore with owners a chance to minimize estate and gift taxes by gifting shares to younger family members involved in the business.

With the current economic downturn causing dislocations and struggles for businesses of all sizes, family-owned businesses may find their values diminished along with their immediate prospects. But with these challenges come opportunities for succession planning. Because closely held businesses may now be worth less than formerly, this might be a good time for tax advisers to explore with owners a chance to minimize estate and gift taxes by gifting shares to younger family members involved in the business.

Example. Mr. Senior owns 80 percent of Deflated Inc. His son and daughter who work in the business own 10 percent each. Deflated was worth $3 million in 2007. By the end of 2008, it was worth $2.5 million. Senior talks to tax counsel and, after exploring the tax strategies and planning tools discussed below, decides to give each child shares worth $500,000 representing 20 percent of the business. Now each child owns 30 percent and Senior owns 40 percent of the business. The tax advantages are:

  • The stock gifted to each child was previously worth $600,000. If Deflated Inc. goes back up in value once the economy recovers, Senior has in effect transferred $200,000 to his children ($100,000 each) free of estate and gift taxes. At a current marginal estate tax rate of 45 percent, Senior’s family can save $90,000 (45% x $200,000).
  • The gifts still leave each child with a minority interest in Deflated Inc. Estate and gift tax valuation practices can include discounts for a lack of controlling interest as well as for a lack of marketability due to the limited market for such shares. Advisers should be aware, however, that these discounts are often contested by the IRS and their success often depends on factors that include the types of assets underlying the business interest and the method, experience and qualifications of the appraiser. See, for example, Appeals Coordinated Issue Settlement Guideline UIL 2031.01 and Tax Court cases summarized in Valuation Discounts for Estate and Gift Taxes. Also, be aware that Congress could limit this tax strategy. President Barack Obama’s fiscal 2010 budget blueprint includes a proposal to disregard such discounts for restrictions that will lapse or may be removed by the transferor or family. Also, a bill to reform the estate and gift tax (HR 436) currently in the House Ways and Means Committee would forbid minority interest discounts for assets “not used in the active conduct” of a trade or business. While these proposals have a long way to go before they could become law, they’re worth watching.

In some cases, discounts for minority interests and lack of marketability can be 25 percent or more (for a recent example of a large family farming operation successfully claiming a 25 percent discount for lack of marketability and a significant discount for lack of control, see Litchfield v. Commissioner, TC Memo 2009-21). If Senior is able to claim a similar discount, the gift of each $500,000 would be reduced by another $125,000. At a current marginal estate tax rate of 45 percent, Senior’s family can save another $112,500 (45% x $250,000).

This article has been excerpted from the Journal of Accountancy. View the full article here.