Three popular strategies have emerged for business owners to move their interests from their estate to directly benefit their heirs, while reducing tax exposure and maximizing wealth. By understanding all three, you can make the correct choice to ensure your business’ future. The 2018 federal individual estate and gift exemption amount is $11.18 million per individual, with any excess amount taxed at a rate of 40 percent. Illinois’ ceiling, however, is $4 million per person, with the excess taxed at a rate determined by your tax bracket. These are important factors to consider when determining if one of these options is right for you.
(1) The Family Limited Partnership (FLP) is a common technique that can be used to transfer an asset, such as the family business, to the next generation. The general partner in an FLP still remains in control, holding all voting rights and decision-making power, but is able to gift business interests to other partners at discounted values. Additionally, the general partner is able to transfer future business income and asset appreciation to the next generation, greatly reducing their estate.
(2) A Granted Retained Annuity Trust (GRAT) is an irrevocable trust that allows the asset’s owner to transfer the asset’s future appreciation to a beneficiary of their choice. The grantor funds the trust with assets, designates a term, and keeps an annuity payment stream. When the grantor survives the term of the trust, the appreciated asset value in excess of the annuity payment to the grantor passes on to the beneficiaries without any estate or gift tax.
(3) A third option involves selling the business interest to an Intentionally Defective Grantor Trust (IDGT). Similar to the GRAT, the goal is to move the future growth and appreciation of the business outside of your current taxable estate. The grantor funds the trust with a cash gift and sells their interest to the trust in exchange for an installment note. The note will have an interest rate based on the Applicable Federal Rate. When the growth of the business outpaces the Applicable Federal Rate, the appreciated value in excess of the note payments pass to the beneficiaries of the IDGT free of estate and gift taxes.
To learn more about these potential options for your business and determine if they are right for you, contact the attorneys of Rock Fusco & Connelly.