Home prices continue to be weak. Small businesses continue to suffer. Odd as it may sound, such bad economic news has created a golden estate planning opportunity in 2010 for small business and property owners to "gift" these assets to their heirs.
In fact, 2010 may be the best year ever from a tax perspective, to implement a business succession plan or to sign over a big piece of real estate to your children. That's because the transaction would be taxed at the current gift-tax rate, which is zero for the first $1 million of value, then 35% for everything in excess of that amount. If Congress does not extend the Bush tax cuts beyond this year, that gift tax is expected to jump up to a maximum of 55% in 2011. But even if Congress votes to extend the current 35% gift tax rate for another couple of years, it is unlikely that we'll ever see this combination of low taxes and low valuations synchronize so perfectly. If, for example, you were to gift a business valued at $5 million to your children this year, the tax would be $1.4 million. In 2011 the same gift could incur a tax of more than $2 million if the gift tax increases as the law now provides.
Gift-Giving Without Ceding Control
Despite the cold logic of the numbers, however, many small business and property owners are just not psychologically ready to cede control of their assets this year. It is possible to make the gift without fully letting go of the underlying asset.
We recently encountered this scenario in our work with the owner of a Long Island car dealership in his mid-70s. For several years he had been contemplating a succession plan to transfer the business to his son and daughter. But he still wasn't ready to give up control of the dealership he'd been building over the past 40 years. His biggest concern was passing the dealership on to his children in the midst of a serious downturn in the auto industry with the fate of his manufacturer hanging in the balance. Ironically, this uncertainty also made it the best time to make the gift because the total value of the dealership was down significantly, decreasing the amount that would be taxed at the 35% rate.
We found a happy medium by setting up a "his and hers" irrevocable trust. Put simply, we were able to place the business in trust for the business owner's children, but give control of the husband's half of the trust to his wife and the wife's half to the husband. By executing the trust in this manner, the business owner and his spouse were able to lock-in the current tax rates and stay at the helm of the dealership.
Family Limited Partnerships
Another important tool in this type of succession planning is the family limited partnership, which lets business and property owners make detailed provisions for the management of their assets once they are passed on to heirs. While some of these are purely operational--such as setting an organizational hierarchy or directing the allocation of profits--others minimize tax exposure by "devaluing" the estate.
We used this approach this year with another client who was ready to pass full ownership and control of his home-building business on to his children. In this case, we were able to decrease the taxable value of his business by setting specific ownership limitations, including land-use restrictions and a divided ownership structure among his three children. Because these restrictions limited the new owners' ability to sell or transfer the property, they dramatically decreased the appraised taxable value of the property beyond the lowered valuations the business was already experiencing.
The Gamble That Taxes Won't Get Lower
The gift issue is always a bit of a gamble for business owners who can't forecast future tax rates, but the current economic environment is tilting the odds in favor of gifting now.
With no official word from Washington on what's going to happen to the Bush tax cuts in 2011, all we have is speculation that taxes must likely eventually increase to pay for the largest budget deficit, as a percentage of gross domestic product, the nation has seen since WWII. While there has been talk of extending the 35% gift tax rate until 2013, it is highly unlikely that the tax will get any lower anytime soon. Given the government's increased monetary needs and the widely held view that the business cycle is at or near its bottom, it is a good bet that the next two months will be the last, best chance to maximize the gift tax for estate planning purposes.
Mark S. Eghrari is a fellow of the American Academy of Estate Planning Attorneys. His practice is located in Long Island, N.Y., and is devoted to estate planning. More information on the firm is available at www.myestateplan.com.