Brad Pettit—Senior Attorney, National Legal Research Group
"Rather than disposing of stock in a closely held business (by sale or corporate reorganization) at retirement the retiree may decide to transfer all or a portion of the stock by gifts to various family members." Streng & Davis, Tax Planning for Retirement ¶ 7.05[1] (Thomson Reuters Tax & Acct’g 2018). Three important objectives can be achieved by making gifts of closely held business stock to family members:
It eliminates the stock's dividend income from the gross income and the estate of the retiree/donor
It removes the value of the stock from the retiree/donor's estate for federal estate tax purposes upon the retiree's death
It solidifies the interests of the family members receiving the stock as officers of the closely held corporation, enabling them access to corporate executive compensation arrangements and other benefits.
Id.
Making lifetime gifts of closely held business stock to junior family members triggers both gift and estate tax concerns for the donor and his or her future estate. For example, the donor must be concerned with the provision in the Internal Revenue Code (“IRC”) that says that "[i]n the case of gifts (other than gifts of future interests in property) made to any person by the donor during the calendar year, the first $10,000 of such gifts to such person shall not, for purposes of subsection (a), be included in the total amount of gifts made during such year." 26 U.S.C. § 2503(b)(1) (Title 26 current through P.L. 115-242). The donor must also concern himself or herself with the special valuation rules that apply in cases involving transfers of certain interests in corporations or partnerships to or for the benefit of a member of the transferor's family, which are found in 26 U.S.C. § 2701. The donor should also consult Revenue Ruling 93-12, 1993-1 C.B. 202, which sets forth, inter alia, minority-interest discount rules for valuing a gift of a minority block of stock in a closely held corporation to a family member.
As to the estate tax implications of lifetime gifts of closely held business stock to family members, the IRC cautions that the value of stock or any other property that was gifted by a decedent during his or her lifetime is includable in the donor's gross estate if the decedent/donor "retained for his life or for any period not ascertainable without reference to his death or for any period which does not in fact end before his death—(1) the possession or enjoyment of, or the right to the income from, the property, or (2) the right, either alone or in conjunction with any person, to designate the persons who shall possess or enjoy the property or the income therefrom." 26 U.S.C. § 2036(a). The Treasury Regulations provide that "[i]f the decedent retained or reserved an interest or right with respect to all of the property transferred by him, the amount to be included in his gross estate under section 2036 is the value of the entire property, less only the value of any outstanding income interest which is not subject to the decedent's interest or right and which is actually being enjoyed by another person at the time of the decedent's death." 26 C.F.R. § 20.2036-1(c)(1). Accordingly, "[a] retiree should not retain enjoyment of or other control over the stock in order to avoid inclusion of the stock in the retiree's estate for federal estate tax purposes." Streng & Davis, supra, ¶ 7.05[3][b].
The authorities cited indicate that if a retiring owner of a closely held business wants to transfer the business to other family members by making gifts of stock in the business, he or she should make the gifts in such a way as to avoid or minimize potential gift or estate tax liabilities. NLRG can help our attorney clients wade through the myriad tax laws and regulations that apply in cases involving lifetime gifts between family members of stock in closely held businesses.
