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Effective estate planning requires taxpayers (especially those subject to estate tax) to have a proper plan in place for all assets. Oftentimes, individuals fail to properly plan for the estate tax as it relates to business entities (corporations, LLCs, etc.), thus missing out on substantial estate tax savings. A complex estate planning technique available to individuals who own entities with significant value is the gift-sale transaction.

Gift-sale transactions involve the transfer of an interest in a business entity to an irrevocable trust and thus outside of one’s estate. The trust will be for the benefit of your designated beneficiaries, typically family members. As the name suggests, the transaction involves two parts; a gift of a specified interest in the entity, and a sale of the remaining interest. The gift portion of the transaction will be used in conjunction with your remaining estate tax exemption amount (currently $5,490,000 for 2017, less any previous gifts); and the sale portion can utilize a long term, interest-only promissory note. In the end, the trust will own the shares of the business entity and you will hold the note in the amount of the sale price of the shares.  

Gift-Sale Transaction Steps

Practically speaking, the transaction will work in the following steps:
  1. You must first determine which entity you wish to transfer.
  2. Preparation of Irrevocable Trust to receive the entity (if one does not already exist).
  3. A valuation of the entity must be done, to determine the specific value of the interests being transferred. Such valuation will often contain discounts for lack of control and lack of marketability.
  4. Once the transfer value has been determined, you must analyze the amount of your remaining estate tax exemption, and determine how much should be allocated to the gifting portion of the transfer.
  5. After the gifting portion has been made, the balance of the business interest will be sold for an interest-only promissory note.

An Example of the Gift-Sale Transaction in Action

The effect of this transaction can be best illustrated by the below example. Please note the following assumptions for ABC Partnership, LP (ABC):
  • Value of ABC: $40,000,000
  • Ownership of ABC: 99% combined ownership by Spouse 1 and Spouse 2 as limited partners; 1% owned by XYZ Enterprises, LLC as general partner
In this example, Spouse 1 and Spouse 2 will only transfer 10% of their combined 99% interest in ABC. Additionally, since the interest being transferred is a limited partnership interest, discounts will likely be applied to the transfer, which will be confirmed by the requisite appraisal. The discount in such a scenario is typically 25%-35%, so for purposes of this explanation, we will use 30%.
 
The original value of the 10% interest being transferred by the spouses is $3,960,000 (10% of $39,600,000). However, after applying the above-mentioned 30% valuation discount, this 10% interest to be transferred has a value for gift tax purposes of $2,772,000. 
 
Now that the value of the total interest to be transferred has been determined at $2,772,000; the next step is to calculate the amount that will be allocated as a gift. For purposes of this example, we will assume that 10% of the $2,772,000 will be treated as a gift resulting in a gift of $277,200. This gift will require a gift tax return, which can be split equally, thus utilizing only $138,600 of each spouse’s $5,490,000 estate and gift tax exemption. Additionally, the spouses can also choose to allocate the same portion of their GST exemption to the irrevocable trust.
 
The balance of the value, $2,494,800, will be sold to the irrevocable trust for a 30-year promissory note. The current IRS minimum interest rate for such transactions is 2.5% per year which will be paid from the trust to the spouses.  
 
The final result of the transaction is that spouse 1 and spouse 2 will have removed 10% of the value of ABC (currently valued at $3,960,000) outside of their respective estates while only utilizing $138,600 of their respective estate tax exemptions. Additionally, all appreciation that accrues relative to the 10% of ABC owned by the irrevocable trust will do so free of the estate tax. 

Contact Top Boca Raton Estate Attorneys Today

If you are an individual that is worried about the inevitable estate tax so to the size and value of your business entities, contact Morris Law Group today to discuss if a gift-sale transaction may be an appropriate course of action with one of our experienced estate attorneys. 

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