You can transfer your business by using a family limited partnership (FLP), an S corporation, or a limited liability company (LLC).
Typically, your business would be organized as one form of these entities at the outset, or you would place your stock or other interest into one of these entities. You then create multiple classes of stock or interests, retain one class of stock or partnership interest, and then gift the other type of stock or partnership interest away to your heirs using another one of these entities.
By using this strategy, you can usually retain control of your company and still gift part of the company to your children or other beneficiaries. You may also be able to discount the value of the gift. In some ways, using one of these entities is similar to simply recapitalizing the existing capital structure of your company. However, there may be other reasons (tax and otherwise) that you may want to use one of these other entities to transfer your business.
Why Use Another Entity to Transfer Your Business?
May Allow You to Retain Control of Company
You may want to use another entity to transfer your business to your beneficiaries if you would like to retain control of your company for either a specified period of time or for the rest of your life. For example, with an FLP, you could transfer your company or stock to the FLP, retain the general partnership interests for yourself (and possibly your spouse), and then gift the limited partnership interests to your children. In this way, you can continue to control the operations of your company while still transferring some of the value of the company to your children. Similarly, with an S corporation, you could transfer your business to an S corporation, create voting and nonvoting shares, and then retain the voting shares for yourself while gifting the nonvoting shares. With an LLC, you can also create two classes of equity (membership interests) and retain the controlling interests while gifting the noncontrolling interests.
Transfers of Nonvoting Interest May Be Discounted
Another advantage to using one of these entities to transfer your business is that the value of the interests that you gift can usually be discounted (for federal gift tax purposes) from the underlying value that the interests represent. The value can be discounted because, typically, there is no resale market for these types of interests (called a lack of marketability discount). The value of the gift can also be discounted because the interests represent a minority (and nonvoting) stake in the company. Most people would be very hesitant to buy a minority interest in a closely held company, especially if that interest is also nonvoting. Usually, the interests can be discounted anywhere from 20% to 40% from the underlying value of the interests.
Example(s): You set up an FLP and transfer your business to the partnership. You create two classes of partnership interests: general partnership interests (which you retain) and limited partnership interests (which you will gift to your children). Because there is no resale market for the limited partnership interests and because the limited partnership interest will have no right to control the operation of the partnership, you can discount the value of the limited partnership interests from their underlying value.
If you used a 25% discount, for example, you could gift almost $13,000 worth of limited partnership interests but only value the gift at $10,000. If you were making gifts to several children (and the gifts qualify for the annual exclusion), you could transfer a substantial portion of the company's value to your children over time without incurring federal gift taxes (although you may still owe state gift tax).
Gifts of Other Interests May Qualify For Annual Gift Tax Exclusion
When you transfer your closely held company to one of these other entities and then gift the nonvoting interests, the gift may qualify for the annual gift tax exclusion. The gift will qualify for this exclusion if the donees have a present interest in the gift (i.e., have the immediate right to the use, control, and enjoyment of the transferred property). In 2019 and 2020, you can make a gift of up to $15,000 per donee per year. A married couple can split the gift and give an amount equal to double that amount as long as both spouses are U.S. citizens and the gift is made jointly. By using the annual exclusion and the valuation discount discussed previously, you can transfer a substantial part of the value of your company to your beneficiaries without incurring any federal gift taxes.
S Corporation May Save You Taxes
You may want to transfer your business using an S corporation if you are planning to pay a dividend on the transferred shares. An S corporation is taxed like a partnership in that any earnings are passed through to the shareholders and are taxed only at the shareholder level. With a C corporation, you may have double taxation of the corporation's earnings: once at the corporate level and then again at the shareholder level if the earnings are paid out as dividends. Therefore, if you would like to transfer shares to your beneficiaries and then pay a dividend on those shares, you may want to consider using an S corporation as the vehicle to gift the shares. However, there are specific restrictions on who may be a shareholder in an S corporation, how many shareholders there may be, and other limits on the structure of the S corporation (including a limit of one class of stock).
Transferred Interests May Not Be Included In Your Taxable Estate
The interests, including any appreciation in those interests that you transfer to your beneficiaries will not have to be included in your estate. Thus, transferring your company through an FLP, an S corporation, or an LLC can be an excellent way to freeze a portion of the value of your company for estate tax purposes.
This material was prepared by Broadridge Investor Communication Solutions, Inc., and does not necessarily represent the views of The Retirement Group or FSC Financial Corp. This information should not be construed as investment advice. Neither the named Representatives nor Broker/Dealer gives tax or legal advice. All information is believed to be from reliable sources; however, we make no representation as to its completeness or accuracy. The publisher is not engaged in rendering legal, accounting or other professional services. If other expert assistance is needed, the reader is advised to engage the services of a competent professional. Please consult your Financial Advisor for further information or call 800-900-5867.
The Retirement Group is not affiliated with nor endorsed by fidelity.com, netbenefits.fidelity.com, hewitt.com, resources.hewitt.com, access.att.com, ING Retirement, AT&T, Qwest, Chevron, Hughes, Northrop Grumman, Raytheon, ExxonMobil, Glaxosmithkline, Merck, Pfizer, Verizon, Bank of America, Alcatel-Lucent or by your employer. We are an independent financial advisory group that specializes in transition planning and lump sum distribution. Please call our office at 800-900-5867 if you have additional questions or need help in the retirement planning process.
The Retirement Group is a Registered Investment Advisor not affiliated with FSC Securities and may be reached at www.theretirementgroup.com.