Before your clients start gifting stock …
Coach them about options and outcomes.
May 7, 2012
A past article discussed whether clients should have their children pay for stock in the family business vs. gifting the stock. An illustration in that article showed the economic advantages of gifting stock. Until the end of 2012, clients will have the luxury of making substantial gifts to their children by taking advantage of the $5.12 million gift tax exclusion and the generation-skipping tax exemption in passing stock along to children, which, as discussed below, may be a better option than transferring small amounts designed to fit under the annual gift tax exemption over a number of years.
Before the 2011–2012 window allowing large stock gifts, most practitioners saw situations in which parents dribbled out their stock ownership to children over an extended period of time. This approach requires a complete business valuation to determine the fair market value of the stock at the time of the gift that meets the IRS-imposed adequate disclosure requirements. These requirements are very specific about what documentation must accompany a gift tax return and apply to gifts made after Aug. 5, 1997. (See Regs. Secs. 20.2001-1; 25.2504-2; and 301.6501(c)-1(e) and (f).)
A thorough valuation requires someone highly skilled, often with a special certification or designation to perform a comprehensive analysis to determine the value of the business—a complex and time-consuming process that is essential to comply with IRS rules. And no matter how well documented, both the stock value conclusion and any discounts taken for a minority position and/or lack of marketability of the business interest are subject to over- or undervaluation penalties if the business appraiser misses the mark in the IRS’s view.
So, even if it initially appears that making small annual stock gifts (currently up to $13,000 from one donor or $26,000 if it’s a joint gift) is a great way to transition ownership without using any part of a client’s unified credit, the administrative cost of having the stock valued every year can be steep (between $5,000 and $10,000 to value a relatively small business). Even if clients use the appraised value as of Dec. 31 and Jan. 1 of the following year as being the “same” (thereby allowing double use of an appraisal), the process can still be fairly expensive for clients. Typically, there are also legal fees and gift tax return filings to complete the gifting process that further increase this strategy’s administrative costs. In addition, with a growing company, the annual gifting approach may not sufficiently decrease the value of a client’s estate fast enough to keep up with the growth in stock value.
Coaching tips for clients on stock gifting
Following are four coaching tips advisers may want to consider for their clients:
Given that some of these issues relate to smaller annual gifts, clients can avoid dealing with them by completing large gifts prior to the end of 2012. Other concerns a CPA can address involve developing tax-efficient strategies to transition assets to inactive family members, creating structures that protect assets in the event of a divorce, and having open discussions to set clear expectations among family members and key employees.
It is not unusual for the siblings and co-workers of successor children who are active in the family business to take a negative view of parent-to-child stock gifts, questioning the “fairness” of an ownership transition that occurs through gifting. This is another case in which communication can go a long way in establishing ground rules that make it possible for children to legitimately “earn” their equity without officially paying for it. Some examples:
In an upcoming article, I will discuss why clients should not rely on their estate plans to deal with transitions of business ownership.