Many families have spent generations building successful businesses and have generated significant wealth that they want to keep in the family, without requiring their estates to sell such businesses or take out significant loans in order to pay estate taxes owed at the owner’s death. While the business owner’s estate can elect to pay estate taxes over a period of years (referred to as the 6166 election), there are also planning techniques that can be implemented during the business owner’s lifetime that can significantly minimize, or altogether eliminate, this dilemma at death.
One popular estate planning strategy involves gifting or selling a business interest to a defective grantor trust. This technique is used by many business owners because it is a tax efficient way to transfer one’s business to the next generation while incurring minimal or no gift taxes. The key advantages to this transaction include:
• Utilizing the business owner’s available federal gift tax exemption, which is currently $5,490,000 per taxpayer (or $10,980,000 for a married couple)
• Removing the gifted business interest and future appreciation from the business owner’s gross taxable estate and allowing the value of such interest to pass to a trust for the benefit of the business owner’s children and grandchildren
• Permanently shielding the assets that are held in the trust from federal estate and generation-skipping transfer taxes, including all future appreciation (provided that the assets remain in trust)
• Protecting the assets from future liabilities and/or creditors
A gift or sale to a defective grantor trust must be irrevocable in order to achieve the key tax benefits and cannot be undone once the gift is completed. Therefore, before implementing this strategy, several key items should be discussed with the business owner’s advisors, including how much of the business should be gifted or sold to the next generation, what the owner’s current and future cash flow needs will be and what the overall succession plan is for the business. Business owners who wish to minimize estate taxes at death should strongly consider advanced estate planning techniques, including a gift or sale to a defective grantor trust.