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Heidi Bolger

Before your clients start gifting stock …

Coach them about options and outcomes.

May 7, 2012
by Heidi Bolger, CPA/ABV

A past article discussed whether clients should have their children pay for stock in the family business vs. gifting the stock. An illustration in that article showed the economic advantages of gifting stock. Until the end of 2012, clients will have the luxury of making substantial gifts to their children by taking advantage of the $5.12 million gift tax exclusion and the generation-skipping tax exemption in passing stock along to children, which, as discussed below, may be a better option than transferring small amounts designed to fit under the annual gift tax exemption over a number of years.

Before the 2011–2012 window allowing large stock gifts, most practitioners saw situations in which parents dribbled out their stock ownership to children over an extended period of time. This approach requires a complete business valuation to determine the fair market value of the stock at the time of the gift that meets the IRS-imposed adequate disclosure requirements. These requirements are very specific about what documentation must accompany a gift tax return and apply to gifts made after Aug. 5, 1997. (See Regs. Secs. 20.2001-1; 25.2504-2; and 301.6501(c)-1(e) and (f).)

A thorough valuation requires someone highly skilled, often with a special certification or designation to perform a comprehensive analysis to determine the value of the business—a complex and time-consuming process that is essential to comply with IRS rules. And no matter how well documented, both the stock value conclusion and any discounts taken for a minority position and/or lack of marketability of the business interest are subject to over- or undervaluation penalties if the business appraiser misses the mark in the IRS’s view.

So, even if it initially appears that making small annual stock gifts (currently up to $13,000 from one donor or $26,000 if it’s a joint gift) is a great way to transition ownership without using any part of a client’s unified credit, the administrative cost of having the stock valued every year can be steep (between $5,000 and $10,000 to value a relatively small business). Even if clients use the appraised value as of Dec. 31 and Jan. 1 of the following year as being the “same” (thereby allowing double use of an appraisal), the process can still be fairly expensive for clients. Typically, there are also legal fees and gift tax return filings to complete the gifting process that further increase this strategy’s administrative costs. In addition, with a growing company, the annual gifting approach may not sufficiently decrease the value of a client’s estate fast enough to keep up with the growth in stock value.

Coaching tips for clients on stock gifting

Following are four coaching tips advisers may want to consider for their clients:

  1. Annual gifting has high administrative costs and may not achieve a client’s goal of reducing the value of stock ownership inside his or her estate if he or she has a growing business.
  2. A client’s children may not want their parents to gift stock to them. If their parents came to own the stock by building up the business themselves, the gift can be viewed as having strings attached, i.e., it’s as if mom and/or dad still own the business. This is an area that requires open and frank discussions within the family. The CPA can facilitate these discussions before binding decisions are made.
  3. Gifting stock becomes very complex if some of the clients’ children are active in the business, while others are not. If the business is the parent’s primary asset that they share fairly with all of their children, this situation will force them to create liquidity out of illiquid business assets. This can be very tricky and generally requires more time to extract the necessary.
  4. Once stock gets shared with married children, the appreciation in value that occurs during the marriage can become a marital asset (depending on specific state laws). In the event of a divorce, having an “in-law” become entitled to a settlement based on appreciated stock value is an unpleasant reality that needs to be dealt with and ends up as yet another demand for business liquidity.

Given that some of these issues relate to smaller annual gifts, clients can avoid dealing with them by completing large gifts prior to the end of 2012. Other concerns a CPA can address involve developing tax-efficient strategies to transition assets to inactive family members, creating structures that protect assets in the event of a divorce, and having open discussions to set clear expectations among family members and key employees.

It is not unusual for the siblings and co-workers of successor children who are active in the family business to take a negative view of parent-to-child stock gifts, questioning the “fairness” of an ownership transition that occurs through gifting. This is another case in which communication can go a long way in establishing ground rules that make it possible for children to legitimately “earn” their equity without officially paying for it. Some examples:

  • Require successor children to work outside the family business before they can take on an official role (after completing their college degrees in fields relevant to the family business).
  • Set commitment and achievement milestones through individual development plans designed to guide the children’s careers and growth as leaders in the business over an extended period of time.
  • Ease children into greater ownership over time, for example, by awarding them nonvoting shares of stock so they can learn how to handle the privileges and responsibilities of ownership before they receive voting control of the business.

In an upcoming article, I will discuss why clients should not rely on their estate plans to deal with transitions of business ownership.

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Heidi Bolger, CPA/ABV, CFFA, CMAP, is a founding principal of Rehmann Consulting and advises clients in the areas of succession planning and business sales.