Business Valuations
Gift vs. Estate Taxes: Is It Always Better to Give …?
Maybe it’s true that it is better to give than to receive. But when to give is a question that tax and valuation experts often ponder. Should an asset be gifted during the owner’s lifetime to reduce the value of his or her estate? Or should the owner hold onto a particular asset and gift another one?
Of course, the answer depends on the nature and value of the asset and the valuation date. Gift tax is computed on a cumulative basis. Under current law, an individual, during his or her lifetime, can transfer taxable gifts up to $1 million without incurring gift tax. There is also an annual gift tax exclusion covering assets of up to $12,000 given to any one person. This amount increased from $11,000 beginning in 2006.
Currently, estates enjoy a one-time tax exclusion on values up to $1.5 million, with this exclusion increasing to $3.5 million by the year 2009. The federal estate tax is completely repealed in 2010. In 2011, the current rules indicate a reversion to the pre-2001 tax exclusion on values of up to $1 million.
What It’s Worth
When? Assets are valued differently at different times. For gift tax purposes, assets are valued when given. For estate tax purposes, assets are valued at the time of owner’s death or six months after death.
How? Assets are valued differently depending on whether they represent a controlling interest or a minority interest. For the purposes of estate tax, value is determined at the decedent’s level, so a controlling interest receives less discount in a valuation. Even if the owner has a minority interest but is bequeathing it in a way that will then give the recipient controlling interest, the asset should still be treated as a minority interest.
terms of gift tax, gifts are valued at the recipient’s level. Thus, a controlling interest divided into minority interests among several recipients is considered a minority interest for gift tax purposes.
At what rate? Gifts are subject to the same tax rates as estates through 2009. After that, the gift tax rate will equal the highest marginal income tax rate. But as of 2004, the applicable credit and exclusion amounts for estate and gift taxes are no longer unified.
As noted in the chart below, for gift tax purposes, an applicable credit amount of $345,800 is allowed against cumulative taxes on lifetime gifts, offsetting the tax on the first $1 million in gifts. For estate tax transfers, the applicable credit for 2006 is $780,800, offsetting the tax on the first $2 million.
(See chart below.)
Estate and gift tax laws change regularly. But one premise is clear: From a tax-savings standpoint, if making gifts today, choose assets that have the most potential to increase in value. By doing so, maximum value is removed from the estate.
And although current law contains exclusion amounts through 2009, no one can predict what Congress will do in the meantime. At this point, it seems that lifetime gifts are the way to go — but professional planning is vital both to reduce gift and estate tax burdens and to stay apprised of potential changes in the law.
Applicable Credit Amounts
Estates
For Transfers |
Taxable Estates |
|
|---|---|---|
Made-in |
The Credit is |
Equivalent |
| 1987-1997 | $192,800 |
$600,000 |
1998 |
$202,050 |
$625,000 |
1999 |
$211,300 |
$650,000 |
2000-2001 |
$220,550 |
$675,000 |
2002-2003 |
$345,800 |
$1,000,000 |
2004-2005 |
$555,800 |
$1,500,000 |
2006-2008 |
$780,800 |
$2,000,000 |
2009 |
$1,455,800 |
$3,500,000 |
GIFTS
For Transfers |
||
|---|---|---|
Made-in |
The Credit is |
Taxable Gift |
| 1987-1997 | $192,800 |
$600,000 |
| 1998 | $202,050 |
$625,000 |
| 1999 | $211,300 |
$650,000 |
| 2000-2001 | $220,550 |
$675,000 |
| 2002 & thereafter | $345,800 |
$1,000,000 |
Source: PPC’s Guide to Practical Estate Planning, May 2005
FLP Do’s and Don’ts
Over the past few years, Family Limited Partnerships (FLPs) have become popular financial planning tools. Typically, an individual transfers assets to an FLP and transfers ownership of limited partnership interests to family members. Because the transferred interest is normally not controlling and not readily marketable, valuation discounts apply, reducing the value for estate and gift tax purposes.
While the IRS continues to attack the legitimacy of FLPs, the courts have generally upheld them. The IRS has had the most success undoing taxpayers’ plans when the FLP has been improperly administered. This has allowed the IRS to argue that there was a transfer with a retained interest, that the individual donating the assets never intended to give up personal use, or that the transaction was simply a sham.
Here are a few tips to help keep an FLP out of trouble:
- Don’t put personal assets like a personal residence or an annuity into the partnership.
- Set up a separate bank account for the FLP.
- Don’t commingle personal and partnership assets, and don’t pay personal expenses out of the FLP.
- Make sure the partners have enough assets to live on.
- Make sure all assets are legally transferred to the partnership and held in its name.
- Make deposits directly to the partnership.
- Report income in the partnership’s name on K-1s and 1099s.
- Ask vendors to bill directly to the partnership.
- Don’t use partnership assets as collateral or list them on personal financial statements.
- Keep books and records in accordance with the partnership agreement.
A well-written partnership agreement and a proper valuation are also essential to stave off an IRS attack.
For more information about our business valuation services, Contact:
Freddy Thomas, Senior Manager, Business Valuations at 972.448.6937.
The articles in this newsletter are general in nature and are not a substitute for accounting, legal, or other professional services. We assume no liability for the reader's reliance on this information. Before implementing any of the ideas contained in this publication, consult a professional advisor to determine whether they apply to your unique circumstances.