Minimizing The Estate And Gift Tax Consequences

Ron Oddo

The key to transferring large amounts of wealth was discussed 2000 years ago by the patron saint of estate planning attorneys, Archimedes.

Regarding leverage he observed, “Give me a place to stand and I will move the earth.” Using leverage to move the earth—or to move your wealth—is the key to achieving noteworthy results. Each U.S. resident can give away, during lifetime, $5 million as well as the current annual gift exclusion.

An example:

George Delveccio’s CPA (also a Credentialed Business Appraiser) valued the business at $12 million, a conservative but supportable valuation. The company’s stock was recapitalized into voting and non-voting stock. Based on current Tax Court case law, CPA could justify discounting the value of non-voting stock (or a gift of a minority interest of the voting stock). In her opinion, the minority discount was 35% of the full fair market value of the stock. Thus, she reduced the “size of the earth” by 35%, and was well on her way to leveraging the use of the Delveccio’s lifetime exemption amount.

Even with the 35% discount, however, a gift of 50% of the company (now reduced to approximately $4 million in value) would cause gift tax consequences if George and Eunice also made gifts of equivalent value to each of the other two kids.

Like every other business owner, George was not particularly keen on paying taxes. So he didn’t. And he still gave away 50% of the company to Chad. He did so by using one of the biggest levers in Archimedes’ arsenal—one of the biggest levers in the “Wealth Preservation Transfer Game”: a “GRAT”—a Grantor Retained Annuity Trust.

A GRAT is but one of many tools that a lot of clever minds—legal tax and insurance—have created to produce or eliminate estate tax. When these estate planning concepts and tools are combined with lifetime exit planning concepts and tools they work to achieve an owner’s lifetime and estate planning objectives.

The keys to success are:

1) Intelligent use of gift and estate tax reduction concepts;
2) Time (because many of these tools work more effectively over time); and
3) Capable and coordinated advisors working in your interest.

How GRATs Work.

After first obtaining a professional valuation of his company George created a GRAT. A GRAT is an irrevocable trust into which the business owner transfers his stock. George transferred all of his non-voting stock–which represented 50% of the overall ownership interest in the company.

The GRAT must make a fixed payment (annuity) to George each year for a pre-determined number of years. At the end of this time period, which is established when the trust is created (usually two to ten years) any stock remaining in the trust is transferred to the children.

A gift is made when the stock is transferred into the GRAT. The amount of the gift is the value of the asset transferred minus the present value of the annuity that the owner will continue to receive. In George’s case, his advisors designed the value of the annuity to be equal to the value of the stock transferred into the trust. Therefore, George only made a small gift of a few thousand dollars when he transferred his stock to the GRAT. To calculate this present value the IRS requires the use of its federal midterm interest rate (currently about two percent). The owner acts as the Trustee (the person in charge of the management of the trust assets, in this case the stock of the company).

Ideally, a GRAT includes an asset that appreciates in value and/or produces income (or grows in value) in excess of the Federal mid-term interest rate. This rate adjusts monthly, but is currently near historic lows.

Most successful businesses, including George’s, easily exceed this IRS-mandated threshold. This is especially true when we design the gifting to take advantage of the additional leverage in the form of using a minority discount on the original transfer of the business interest to the GRAT.

Here is where it really gets interesting: George’s advisors matched up the amount of the expected “S” distributions payable with respect to the stock transferred into the GRAT (over $1 million per year) with the annual annuity payment (also a bit over $1million per year).

Thus, at the termination of the four-year GRAT, all of the stock originally transferred to it remained in the GRAT (only the “S” distributions with respect to the transferred stock were needed to satisfy the annuity payments). That meant that all of the stock remained and was distributed to Chad tax-free. George paid no gift taxes and his income tax liability during the four-year GRAT period was the same as if he had not made a gift to the GRAT.

Let’s summarize what George did:

1. He transferred one-half of a business with a fair market value of between $12 million and $15 million to Chad in four years without using his lifetime exemption.
2. He continued to receive all of the income from the company during that four-year period.
3. At the termination of the trust (four years) the trust assets, (all of the non-voting stock) were transferred to Chad.
4. George incurred minimal gift tax consequences.

(The abolishing of estate taxes is a goal for man people in 2017)

Ronald Oddo

Certified Exit Planner with more than 28 years of experience preparing business owners for the day they will exit from their business. I am qualified to provide this needed service to business owners based on my education, experience, knowledge and skills. I have earned and maintain nine business related certifications and six security licenses. In addition, I am a Federally Licensed Tax Practitioner with the privilege of representing troubled taxpayers before the IRS. To stay as current as possible I enjoy membership in 17 professional associations. On a day-to-day basis I manage a fully staffed tax, accounting and financial planning practice which provides all of the resources for our Exit Planning Clients.

My definition of Exit Planning is the preparation for the exit of a business owner from the company, with an emphasis on maximizing the enterprise value of the company. Exit planning also embraces a path toward non-financial objectives including the transition of the company to the next generation, sale to employees or management, or other altruistic, non-financial objectives.

My mission is to help you create a comprehensive road map that will accomplish your personal and financial goals when you decide to leave the business. As your Exit Plan advisor I will bring together a team of experts in Taxation, Law, Financial Planning, Estate Planning and Investment Banking that will guarantee that you will exit your business in style.

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