Gifts to individuals of business interests in general that are less than $14,000 do not have to be reported to the IRS. Gifts in excess of that amount must be reported through a gift tax return. This can more complex when business interests are the subject of the gift.
Business interests are often subject to income taxes due to the fact that the income tax basis of the business may be less than its fair market value at the time of the gift. Gifts of business therefore are done with the expectation that no sale will occur during the grantor’s lifetime.
The tax planning issues involved with gifts of a business include the following:
- Will the value of the asset grow over time so that the increased value at death would be greater than the income tax to be paid if the business is later sold?
- Will the recipient sell the asset or instead hold the asset until the death of the recipient thereby getting a fresh step-up in basis at that later date? This is often referred to as an “estate freeze”?
- Will the transfer of shares of the business (which provides for minority interest discounts for estate and gift tax purposes) prove to be counterproductive when the lifetime exception amounts would be sufficient to protect the estate from taxes?
- Gifts must be appraised. Appraisals involve the business itself and the gift specifically to determine the amount of minority interest and marketability discounts to be applied. For example, if a 50% discount is applied to a gift of $10,000, the actual amount of gift transferred is $20,000 although only $10,000 is reported for gift tax purposes.
The non-tax planning issues involved with gifts of a business include the following:
- Is the recipient of the gift capable of managing the business? For example, is the recipient a minor or someone who doesn’t understand the true value of the gift being made or is not yet capable of managing the gifted business?
- Will the recipient be able to protect the gifted share of the company from creditors including any claims that might occur if a divorce is filed? It is important that the operating agreement and the buy-sell agreement of the company is brought up to date prior to gift being made.
- Will the recipient of the gift be disruptive to the operation of the business and those that work for it? This can be of critical importance as it relates to key persons at the business who make take a different view of gift.