Exit Planning Gifting Strategies
Exiting business owners have several gifting strategies available to transfer ownership, particularly when the goal is to pass the company to family members or key employees in a tax-efficient manner. These strategies can help minimize tax liability, ensure business continuity, and preserve family wealth. Here are some of the common gifting strategies along with their advantages and disadvantages:
- Outright Gift:
The owner can simply transfer ownership of the business outright to a family member or designated recipient. This is a straightforward approach where ownership is transferred in one step.
The advantages of an outright gift include that it is simple to execute and can be done quickly and that the recipient gains immediate control of the business.
The disadvantages of an outright gift, on the other hand, are that if the gift exceeds certain limits, gift taxes may apply and that the owner loses control of the business entirely upon gifting.
- Gradual Gifting – The Annual Gift Tax Exclusion:
The owner can gift portions of the company over time, taking advantage of the annual gift tax exclusion. In 2024, the exclusion is $18,000 per recipient, meaning the owner can give up to this amount tax-free each year to any number of individuals. In 2025, the exclusion is expected to move up to $19,000.
Advantages of gradual gifting are: (i) that gradual gifting allows the owner to gradually reduce their ownership while minimizing or avoiding gift taxes, and (ii) that it reduces the risk of overwhelming the recipient with immediate control of the entire business.
Disadvantages of gradual gifting are: (i) that this process can take several years to transfer significant portions of the business, and(ii) that the gift tax exclusion limits may not be sufficient for a large business.
- Family Limited Partnership (FLP):
An FLP allows the business owner to transfer ownership interests in the company to family members while retaining control over the business operations. The owner can gift limited partnership shares to family members while keeping general partner control.
The pluses of an FLP are that the owner can retain control while gradually gifting interests to family members, and interests can be gifted at a reduced value due to minority ownership or lack of marketability, reducing the gift tax burden.
The minuses associated with an FLP are that the IRS may challenge the valuation of the gifted shares and the legal and administrative complexities in setting up and managing the FLP.
- Grantor Retained Annuity Trust (GRAT:)
A GRAT allows the owner to transfer ownership of the business into a trust while receiving an annuity payment over a set number of years. After the term ends, any remaining business interest passes to the beneficiaries without additional tax.
The advantages of a GRAT are that if the business appreciates in value during the term of the GRAT, the appreciation passes to the beneficiaries free of gift or estate taxes. In addition, the owner retains an income stream during the trust term.
Disadvantages attributed to a GRAT are that if the owner dies before the trust term ends, the business may be included in the owner’s estate, as well as the GRAT’s upfront administrative and legal costs.
- Installment Sale to Family Member or Trust – aka, an Intentionally Defective Grantor Trust – IDGT:
Under an IDGT, the owner sells the business to a trust for the benefit of family members, receiving installment payments over time. The sale can be structured as a loan, with interest payments.
The advantages of an IDGET are that the business can be sold at today’s value, freezing the business’s value for estate tax purposes and that he or she can receive a steady income stream from the installment payments.
The disadvantages associated with an IDGET are that interest payments from the loan may result in taxable income for the seller, and that if the business underperforms, the family member may struggle to make payments.
- Charitable Remainder Trust – CRT:
A CRT allows the owner to transfer ownership of the business into a trust, where they receive income from the trust for life or a set term. Afterward, the remainder of the trust passes to a charity.
CRT’s are advantages to an owner because the owner receives a charitable deduction for the donation, avoids capital gains taxes on the sale of the business and the CRT can provide an income stream for the owner or family members.
A CRT’s disadvantages are that the business will not stay within the family after the trust term ends and that the charitable giving must align with the owner’s personal goals.
- Self-Canceling Installment Note (SCIN:)
When gifting with a SCIN, the owner sells the business to a family member in exchange for an installment note. If the owner dies before the note is fully paid, the remaining debt is canceled, and the family member receives the business without further payment obligations.
The advantages of a SCIN are that a SCIN provides an income stream during the owner’s life, in addition to potentially allowing for the transfer of the business without estate or gift taxes if the owner dies early in the note’s term.
The disadvantages of a SCIN are that if the owner lives longer than expected, the family member may end up paying more for the business than its fair market value. SCINs also require careful structuring to avoid IRS scrutiny.
- Gifting Through an Employee Stock Ownership Plan (ESOP:)
The business owner can gift shares to an ESOP, which is a retirement plan for employees. Over time, employees acquire ownership in the company through the ESOP.
The three main advantages to gifting through an ESOP are that this strategy: (i) offers tax advantages to both the owner and the company, (ii) provides a retirement benefit to employees and can improve morale and productivity, and (iii) that the owner can maintain partial control while gradually transitioning out.
Two disadvantages of this gifting strategy are that ESOPs are complex and expensive to set up & administer and that the business must generate sufficient cash flow to fund the ESOP.
- Private Annuity:
Under a private annuity gifting strategy, the business owner transfers the company to a family member in exchange for a lifetime annuity and the family member makes regular payments to the owner until their death.
The advantages of gifting private annuity are that the annuity provides lifetime income for the owner without estate taxes and the owner can avoid gift taxes if structured correctly.
The disadvantages of this gifting strategy are that if the owner lives longer than expected, the family member may pay more than the company’s fair market value and that the family member must have sufficient cash flow to make the annuity payments.
In conclusion, choosing the right gifting strategy depends on the owner’s objectives, financial situation, tax considerations, and the needs of the recipient. Many of these strategies require careful legal, tax, and estate planning to ensure they are implemented effectively. Consulting with financial advisors, tax professionals, and attorneys is essential to selecting and executing the most appropriate approach.
About Greater Prairie Business Consulting, Inc.:
Greater Prairie Business Consulting, Inc. is an award-winning, national consulting practice serving entrepreneurs, small to mid-sized privately held and family-owned businesses and middle market companies of any type with revenues between $1 million and $250 million. The firm helps small, mid-sized and middle market companies maximize their performance and exit.
Greater Prairie Business Consulting, Inc. can be reached by calling 1-800-828-7585 or emailing info@gpbusinesssolutions.com.
About the Author:
James J. Talerico, Jr. is an award-winning author, speaker, and a nationally recognized small to mid-sized (SMB) business expert.
With more than thirty- (30) years of diversified business experience, Jim has a solid track record and an A+ BBB rating helping thousands of business owners across the US and in Canada tackle tough business problems to improve the performance of their organizations.
His client success stories have been highlighted in the Wall St. Journal, Dallas Business Journal, Chicago Daily Herald, and on MSNBC’s Your Business. He was named “Texas Business Consulting CEO of the Year,” by CEO Today Magazine, identified as a “Top 10 Management Consulting Entrepreneur to Watch in 2023” by Entrepreneur Magazine, was listed among the “10 Most Visionary Companies to Watch in 2023” by Inc. Magazine, and has also been ranked among the “Top Small Business Consultants” followed on Twitter.
For more than half a decade, Jim was a regular guest on “The Price of Business,” a nationally syndicated radio program on Bloomberg Talk Radio and has also appeared as a subject matter expert on many FOX Radio interviews. He is a regular contributor to several blog sites and has frequently been quoted in publications like the New York Times, Dallas Morning News, Philadelphia Inquirer, The Entrepreneur’s Review, and on INC.com, in addition to numerous, other industry publications, radio broadcasts, business books, and Internet media.
Jim received a Gold “Stevie Award” for “Thought Leader of the Year,” a Gold “Stevie Award” for “Media Hero of the Year During Covid” and a Bronze “Stevie Award” for “Best Entrepreneur” in the Category of “Business and Professional Services” at the American Business Awards ® in New York City. The competition received more than 3,700 nominations and is the premier accolade for business excellence in the US honoring organizations of all sizes and industries. Jim also received an “Outstanding Leadership Award” at the Money 2.0 Conference for his contributions to the financial services industry.
Jim is the author of “8 Steps to Becoming an ETHICS FOCUSED ORGANIZATION,”™ a small business certification program that utilizes a unique eight – (8) step approach for strengthening ethics in any organization. The certification program won the Better Business Bureau’s “Torch Award for Ethics” for the North – Central Texas Region, the International Better Business Bureau’s “ Torch Award for Ethics,” and a Gold “Stevie Award” for “Ethics in Sales” at the International Sales & Customer Service Stevie Awards ®. Participants who complete this certification program are eligible to receive eight – (8) continuing education units from the University of Texas’ Division of Enterprise Development.
Jim received his Certified Business Exit Consultant (CBEC) ® designation from The International Exit Planning Association (IEPA) to help entrepreneurs, small business owners, family businesses, and middle market companies maximize their business exit, and he received his certification in succession planning from the ASPE.
Jim is also a Certified Management Consultant (CMC) ® and an active member of the Institute of Management Consultants.
