Can I Be Taxed For Gifting My Business?
Many small business owners build their companies to ultimately pass to their children. However, gifting a business is more complex than handing the building keys to the new owner. Family members might pay a hefty price for gifting in the way of gift taxes.
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. 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, helped by a Maryland business tax lawyer, you might be able to avoid gift taxes if you gift your business.
The Annual 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.
If the value of the business interest being transferred between the donor and recipient exceeds the $17,000 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 $17,000 interest in the business in 2023. If spouses own the family business, you can double the annual exclusions meaning the spouses combined could give up to $32,000 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. 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 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 2023, the lifetime estate and gift tax exclusion is $12.92 million. The lifetime exclusion is per donor, so it allows spouses to exclude double that amount in lifetime 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, 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. If you want to gift your business, you might consider doing so before the lifetime gift tax exclusion significantly decreases.
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, the owner gives shares in the corporation to their children.
A parent may want to create a Family Partnership or a Family LLC for their business. Then, they 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.
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.
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.
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 make sure the process goes smoothly and that your children can take over the business with confidence. Schedule a consult with us today if you're ready to plan your gifting strategy.
