Estate Planning: What’s the Next Move?

By William J. Killory, CPA (May, 2012)

We have only 200 or so more shopping days before Christmas this year and while gift giving may not be terribly high on your agenda you may want to think about it as part of your estate plan.  The estate tax and the level of wealth that creates a taxable estate has been all over the map the past few years.  In 2010 there was no estate tax. This year estates over $5,120,000 will be subject to tax at a rate of 35%.  Next year, as it stands now, estates over $1,000,000 will be subject to tax starting at 41% and rising to 55%. 

The gift and estate exemptions have been unified so that if you give away a substantial portion of your wealth now, your heirs will have to add the value of the gift to your estate to determine the estate tax upon your demise.  With a $5 million exclusion available, now may be a time to consider gifting assets to your loved ones.  As long as you don’t exceed the lifetime exclusion amount there is no immediate estate or gift tax due.  The recipients do not recognize income when they receive the gift but may have tax consequences when they sell or dispose of these assets.  For gift tax purposes the gift is valued at fair market value.  For the recipients, the tax basis is the lesser of fair market value or your basis, whichever is lower.  If you are gifting commercial real estate worth $2,000,000 and a tax net book value of $1,000,000 the gift is valued at $2,000,000 and the recipient has a tax basis of $1,000,000.  If the recipient sold the building a week later for market value they would have a taxable gain of $1,000,000.  The holding period for capital gain purposes would be from the time the donor purchased the property so in this case would be considered long term subject to real estate recapture rates.

If this same property was located in Florida and had a market value of $750,000, the gift value would be $750,000 and no gain or loss would be recognized a week later when the donor sold the property.  In this case it would make more sense for the donor to sell the property, take the $250,000 loss and gift the cash proceeds.  This illustrates the need for careful planning on how and what assets to gift.  

For our clients that are planning generational transitions of their businesses, 2012 presents an opportunity to either sell or gift portions of your business.  A gift tax return should always be filed when shares of closely held companies are transferred by family members, even if they are sold at full market value.  Because of the family affiliation the IRS will assume that there was donative intent and therefore a gift was made.  If you file a gift tax return with all the proper disclosures, then the IRS has three years to challenge the valuation.  If a gift tax return was not filed, the IRS can challenge the estate return and make retroactive adjustments on events that occurred decades earlier.

One of the elements of a complete gift tax return with the transfer of a family business is a full valuation performed by a qualified expert.  The expert will look at a variety of information and assess the magnitude of discounts for marketability, control and other such variables that go into a valuation.  If the IRS challenges the valuation and increases the value then there may be additional gift or estate tax due.  There have been some recent Tax Court cases that involved family businesses that gave family members a fixed dollar amount of the estate with the balance going to charity.  The IRS successfully challenged the valuations, increasing the value of the estate but the Tax Court held that any excess would go to the designated charities and there would be no additional estate tax due.  

A Tax Court case from earlier this year extended the logic of that reasoning to setting a predetermined value of the company stock as the gift.  The IRS successfully challenged the value of the company shares gifted but the result was that the shares represented by the additional value reverted to the donor and no additional tax was due.  The IRS is likely to challenge these types of results but for now it does present a rather clever planning opportunity,

Everyone likes Christmas and it is always better to give than to receive or so they say.  When giving significant portions of your estate please contact Dermody, Burke & Brown to help guide you through the process and avoid some of the pitfalls, problems and lost opportunities that gifting can present.


The information reflected in this article was current at the time of publication. This information will not be modified or updated for any subsequent tax law changes, if any.

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