By and large, auto dealerships tend to be individually-owned. Although business succession is often top of mind for dealers, many balk at the idea of gifting their business to family members, as doing so also means giving up the control that comes with ownership.
By first considering a stock recapitalization of the business, the current estate-planning environment allows dealers to take advantage of the $5 million gift, estate, and generation skipping tax exemption, set to expire on December 31, 2012. This increased exemption amount provides a significant opportunity for dealers to shift value to family members but maintain control. Time is of the essence, however, as the exemption is scheduled to be replaced with a $1 million exemption as of January 1, 2013.
Gift, Estate, and GST Taxes
The last decade has seen a record number of changes in gift, estate, and GST tax exemption amounts. The gift tax exemption is the amount of assets that can be transferred during a donor’s life free of gift taxes; the estate tax exemption is the amount of assets that can be transferred at the donor’s death free of estate tax; and the GST tax is the amount that can be transferred during life or at death free of generation skipping tax to beneficiaries who are more than one generation younger than the donor or decedent. While the relationship between these exemptions has changed over time, they are interrelated or unified (for example, a donor’s estate tax exemption is reduced by lifetime gifts made that aren’t taxed due to the gift tax exemption).
Estate and Gift Tax Exemptions and Highest Rates
*The GST exemption will be adjusted for inflation for 2013 and should be approximately $1.4 million.
Strategies for tax-smart giving include:
- To minimize your estate tax, property with the greatest future appreciation potential should be selected for gifting. If your gifting amount is less than $1 million and you’re married, consider making the gift individually, not jointly. Gifting individually will preserve your spouse’s full estate-tax exemption.
- To minimize your beneficiary’s income tax, property that hasn’t already appreciated significantly should be selected for gifting. When a gift is made, the basis in the gift is transferred to the donee. If you select gifts without significant appreciation, the assets can be sold with fewer gains and, therefore, lower income taxes.
- To minimize your own income tax, property that’s declined in value should not be selected for gifting. Unless the property has non-intrinsic characteristics, the property should be sold at a loss and the sale proceeds gifted. As noted above, when a gift is made, your basis is transferred to the donee except when the basis is higher than the fair market value of the gift. If the basis is higher than the fair market value, the higher basis becomes the “gain basis” that’s used if the future sale price is higher than that value. The fair market value at the date of the gift becomes the “loss basis” that’s used to determine any future loss for tax purposes.
Housekeeping. Thanks to the higher gift tax exemption, many individuals are making combined gifts greater than $1 million that haven’t been tax efficient in the past due to gift taxes that would have been owed. If your gift plan was impacted by the lower exemption, now is the time to:
- Finalize gifting for large transfers (land, real estate, or closely held businesses) that had been limited by the lower exemption and by low annual gift exclusion levels (currently $13,000 per year per donee).
- Fund or start an irrevocable life insurance trust. Irrevocable life insurance trusts are used to hold insurance and, if properly structured and funded, the life insurance proceeds will pass directly to your beneficiaries and won’t be included in your taxable estate.
- Complete gifting programs to multiple beneficiaries that were tax inefficient with lower exemption limits.
Case Study: 2012 May Be Your Year
Bill, a widower, has an estate valued at $8 million. Bill regularly transfers gifts valued at $13,000 annually (the annual gift exclusion amount) to each of his children. In 2010, he transferred an additional $1 million in gifts that reduced his gift tax exemption to zero at that time. Bill has a desire to make additional gifts to his children but doesn’t wish to gift the entire $4.12 million allowable under the current gift tax exemption amount. The $4.12 million is calculated by subtracting the $1 million in prior gifts from the current $5.12 million exemption.
Bill, as part of his estate plan, agrees to gift $3 million to his children. Not only will these assets not be included in Bill’s estate, but any appreciation between time of gift and time of his death will also not be included in his estate.
Prior to the increase of the gift tax exemption by the 2010 Tax Relief Act, this $3 million gift would have resulted in a gift tax liability of $1.65 million (assuming a 55% gift tax rate was in effect) since Bill had previously used the entire $1 million gift tax exemption. The $5 million gift tax exemption represents an opportunity for tax-effective gifting that typically isn’t available.