We’ve talked in previous articles about passing on the family business and ensuring that you have chosen the right person for the job.
Also, it is key for you to consider many scenarios when deciding how to transfer your business. If your children are not interested or qualified, you may have to look elsewhere or even consider selling it outside of the family.
One of the important considerations for a business owner with a substantial enterprise in excess of the exemption from federal tax is the consequences after the business is transferred. Under most circumstances, transferring the business to your children will be considered a gift, even if you intend for your children to buy it from you.
If you are determined to keep the business in the family and your children are willing, consider creating a trust that gifts the business to your children but retains a fixed annual payment for yourself and saves estate and gift taxes.
The Grantor Retained Annuity Trust (GRAT) is a trust in which the grantor gifts property. The grantor must retain the right to a fixed annual payment from the GRAT for a certain specified period of time. Ultimately, your children, as the beneficiaries of the GRAT, will receive whatever assets are left over after the period of time ends.
It sounds pretty simple, but it can be more complicated than this. Section 2702 of the IRS Code sets forth the requirements for creating a GRAT and it must be strictly followed in order to avoid gift tax consequences of a significant transfer.
The main requirement is that the grantor retains an interest (the fixed annual payment) and that a member of the family ultimately benefits from the trust. A family member is usually a spouse, lineal descendants, ascendants, and siblings of the grantor. Family members can also be spouses of those individuals.
Another key requirement in order for the GRAT to be valid is that the grantor must have had an interest in the business before and after the transfer.
For example, a father cannot gift the business to a trust and stipulate in the trust agreement that the son receive an annuity payment for 10 years from the trust. If the son did not own any of the business before it was transferred, he is not entitled to an annuity payment, so the GRAT would not be valid.
In this instance, the father would have to keep the annuity payment for himself after the business is transferred to the trust. However, the ultimate beneficiary of the trust would have to be the son or some other qualified family member in order for the GRAT to completely meet the requirements of Section 2702.
There are other types of assets that can be transferred through a GRAT such as stocks, publicly traded securities, interests in real estate, etc., but you can only choose one. Whatever you choose to place in the trust, make sure it is easily valued and doesn’t require an appraisal. This will ensure a fixed annuity payment and avoid further intrusions by the IRS.
Information contained in this article is not intended to be legal advice nor applicable to all situations. For legal assistance, contact an attorney in your state of residence. You can visit Arleen’s website at arleenrichards-law.info.
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