Can I Be Taxed For Gifting My Business? — Thienel Law
[Updated August 2024]
Many small business owners in Maryland work tirelessly to build their companies with the hope of eventually passing them on to their children. However, gifting a business involves more than just handing over the keys to the new owner. Without proper planning, family members could face significant financial consequences due to gift taxes. Consulting with a knowledgeable Maryland tax attorney can help you navigate these complexities and ensure a smooth transition for your business.
State-Specific Considerations for Maryland Business Owners
While Maryland does not have a separate state gift tax, it’s crucial to understand how state-specific laws may impact the overall gifting strategy. Maryland imposes both an estate tax and an inheritance tax, which can complicate the transfer of a business. The estate tax may come into play if the total value of the deceased’s estate, including the business, exceeds the Maryland estate tax exemption.
Additionally, the Maryland inheritance tax applies to certain heirs who inherit property, depending on their relationship to the deceased. Understanding these state-specific taxes and how they interact with federal laws is essential for effective planning.
The Donor is Taxed for the Gift
When you gift your business to anyone, including a family member, the person donating the business pays gift taxes. Understanding who pays the federal gift tax is crucial for proper planning. A gift tax is a federal tax on transfers of property or money. The Internal Revenue Service (IRS) taxes gifts when the giver receives less than the property’s fair market value. However, with help from a Maryland business tax lawyer, you might be able to avoid gift taxes if you gift your business.
The Importance of Business Valuation in Gifting
Before gifting a business, it’s important to have the business properly valued. The IRS scrutinizes the valuation of gifted businesses to ensure the reported value aligns with the fair market value. An inaccurate valuation could lead to disputes with the IRS, resulting in additional taxes or penalties. A certified business appraisal not only helps avoid these issues but also ensures that the gift is properly accounted for under the annual and lifetime gift tax exclusions. Engaging a professional appraiser can provide an accurate and defensible valuation, which is critical for a successful transfer.
Understanding Inheritance Tax and How it Differs From Gift Tax
Understanding the inheritance tax in Maryland and how it differs from the gift tax is crucial for effective estate planning. Additionally, understanding the estate tax and its interaction with the gift tax is essential for comprehensive estate planning. The question “How much is inheritance tax?” is particularly important. In Maryland, inheritance tax is imposed on the privilege of inheriting property from a decedent, and the rate can vary based on your relationship with the decedent and the value of the property received. Unlike inheritance tax, property acquired as a gift during the giver’s lifetime falls under different tax rules. Familiarizing yourself with the tax code and these differences is essential for strategic financial planning.
The Annual Gift Tax Exclusion for Gift Taxes
The IRS sets an annual exclusion for gifts. If the value of the transfer does not exceed the exclusion amount, gift taxes on the transfer of the business are not owed. The annual exclusion for 2023 is $17,000, meaning you can give up to $17,000 to someone in 2023 without incurring gift taxes. The 2024 annual exclusion for gift taxes increases to $18,000.
If the value of the business interest being transferred between the donor and recipient exceeds the $18,000 exclusion amount, the donor will need to file a gift tax return. Remember, the annual gift tax exclusion is between a donor and a recipient.
If you gift your business to several family members, you avoid reporting gifts by limiting each family member to a $18,000 interest in the business in 2024. If spouses own the family business, you can double the annual exclusions meaning the spouses combined could give up to $36,000 to each recipient without needing to file a gift tax return.
If you give your business to your spouse, you need not worry about a gift tax. Gifts between spouses are unlimited and rarely require a gift tax return.
How Does the Lifetime Exclusion for Gift Taxes Work?
The above addresses the requirement to report gifts on an annual basis and how it relates to those subject to the lifetime exemption for gift taxes. If multiple gifts are made between a donor and recipient in a calendar year, the exclusion applies to the aggregate amount of the gifts made in that year. The requirement to report gifts on an annual basis does not mean a gift tax is owed when the gift tax return is filed with the IRS and, in fact, tax may never be assessed for gifts during a donor’s lifetime exceeding the annual exclusion amounts.
Importantly, gift and estate taxes are integrated and assessed over a donor’s lifetime. In addition to the annual gift tax exclusion, there is a lifetime exclusion for estate and gift taxes. In 2024, the lifetime estate and gift tax exclusion, often referred to as the lifetime gift tax exemption, is $13.61 million. The lifetime exclusion is per donor, so it allows spouses to exclude double that amount in lifetime taxable gifts.
Gift tax returns track a donor’s lifetime gifts which are subtracted from the donor’s lifetime exclusion. Depending on the circumstances, the donor might not need to ever pay gift taxes on gifts reported annually to the IRS. However, by general rule, once a donor exceeds the lifetime exclusion, the donor must pay gift taxes.
Another factor to keep in mind if you are considering gifting your business. The lifetime exclusion is scheduled to revert to the pre-2018 amount in 2026. That amount is around $5 million, adjusted for inflation. If you want to gift your business, you might consider doing so before the lifetime gift tax exclusion significantly decreases.
Understanding Generation-Skipping Transfer Tax (GSTT)
If you’re considering gifting your business to your grandchildren, it’s important to be aware of the Generation-Skipping Transfer Tax (GSTT). The GSTT is a federal tax applied to gifts that skip a generation, such as when grandparents transfer assets directly to grandchildren. This tax is in addition to the gift and estate taxes and has its own exemption amount. Proper planning with a Maryland tax attorney can help minimize the impact of the GSTT, especially if you intend to structure the transfer to maximize tax efficiency for your family.
[Add an image]
How Do I Gift My Business to My Children?
How you gift your business depends on the business entity. A sole proprietorship, for tax purposes, is not a separate entity from the owner. The business owner personally owns the business assets. Therefore, the owner is giving personal assets to their children. However, if the business is incorporated, different corporate gift tax rules apply. The owner gives shares in the corporation to their children, following specific IRS regulations for corporate gifting.
When transferring business interests, for example, it's important to understand what constitutes a taxable gift and the associated tax obligations.
A parent may want to create a Family Partnership or an LLC for their business and then give an interest in the partnership or LLC to their children. Likewise, some parents use a trust to give a business to their children. An irrevocable trust allows the parent to give the business to their children while retaining control of the business during the parent’s lifetime. Using these methods may allow for multi-generational gifting of business interests to protect a family business for future generations.
Utilizing Trusts in Business Succession Planning
Trusts can be a powerful tool in business succession planning, particularly for minimizing taxes and retaining control over the business. For instance, a Grantor Retained Annuity Trust (GRAT) allows the business owner to transfer the business to heirs while receiving an annuity payment, thereby reducing the taxable value of the gift. An Intentionally Defective Grantor Trust (IDGT) can also be used to freeze the value of the business for tax purposes while allowing the business to grow outside the estate. These trust strategies require careful planning and should be discussed with a Maryland tax attorney to determine which approach best suits your needs.
Understanding the Implications of Gifting a Business is Crucial Before Making Any Transfers
Gifting a business can be a complicated transaction. In addition to estate and gift taxes, there are many other considerations, including income tax implications. If you want to gift your business to another person, the first step is to consult a business lawyer. An attorney analyzes your business to determine the best way to transfer the interest to another person.
Certain gifts, such as those related to medical expenses and tuition payments for educational expenses, are exempt from taxation.
It is helpful to gather all business records before meeting with the attorney. You need current income statements, incorporation documents, bylaws, and other ownership records. Having these records allows the business lawyer to determine the best way to gift the business to avoid taxes and other unintended consequences for the new owners.
Developing a gifting strategy as early as possible allows you more flexibility and control over the transfer to maximize the tax exclusions. Planning a succession strategy also allows you to prepare your children to operate the business instead of simultaneously throwing them into management and ownership.
Non-Tax Considerations in Gifting a Business
Gifting a business involves more than just tax considerations. It’s important to consider the potential impact on family dynamics, especially if not all children are involved in the business. Additionally, preparing the next generation for ownership and management is crucial. This could involve years of mentorship and training to ensure a smooth transition. Legal ramifications should also be considered, especially if the business has co-owners or shareholders who may be affected by the transfer. A comprehensive succession plan addresses these non-tax issues to ensure the long-term success of the business.
Talk to an Experienced Business Succession Attorney Before Gifting a Business
Gifting a small business to your children is not a straightforward process. It's essential to consider the potential tax implications and to start planning a gifting strategy as early as possible to have more control over the transfer and maximize tax exclusions.
A succession strategy can also help make sure your children are ready to operate the business successfully. If you are a small business owner considering gifting your business to your children, it's vital to seek the guidance of a business succession attorney to ensure the process goes smoothly and that your children can take over the business with confidence. Schedule a consult with Steve today if you're ready to plan your gifting strategy.
