Tax Reform: How Does It Impact Business Succession Planning?

Tax reform under the Trump administration dominated news headlines towards the end of 2017. Now that the Tax Cuts and Jobs Act has been signed into law, many business owners have questions about how it will impact them and their families. Below we discuss one part of the bill that could have an impact on some business owners’ succession plans in 2018 and beyond.

The following discussion is not meant to provide tax or legal advice, but rather to inform business owners and their advisors on changes that may impact the process of transferring ownership of a business.

Changes to Gift & Estate Tax Exclusions

Prior to the new tax bill, the lifetime federal gift and estate tax exclusion amount was $5.49 million for individuals while the annual gift tax exclusion applicable to gifts of money or property was $14,000 for individuals.1 Under the new tax bill, the 2018 lifetime exclusion amount will increase to $11.2 million for individuals and $22.4 million for married couples, while the annual gift tax exclusion for gifts will increase to $15,000 for individuals and $30,000 for married couples.2  The lifetime exclusion will be adjusted annually for inflation through 2025, and will revert back to pre-2018 levels in 2026 unless further legislation is passed to make the changes permanent.3 These changes may impact business owners who have already started or want to start planning to transfer ownership of their business to a family member. The increase to the lifetime and annual gift tax exclusion amounts means that some business owners may be able to make larger gifts of business interests that would have otherwise been subject to gift tax. Or, it may allow some business owners to accelerate gifting strategies they’ve already put in place.

Gift & Estate Tax Overview

Under the new tax bill, a federal estate tax return must be filed if an estate’s gross assets exceed $11.2 million. The value of an estate exceeding the $11.2 million lifetime exclusion will be taxed at 40%, while estates with gross assets below the exclusion amount will generally not be taxed.4 Individuals and married couples may also give gifts to any number of people each year tax-free as long as the value of each gift does not exceed the annual gift tax exclusion amount of $15,000 and $30,000, respectively.5 The purpose of the gift tax and the lifetime exclusion is to prevent individuals from gifting away all of their assets prior to death to circumvent federal estate tax. For that purpose, the lifetime exclusion is actually a unified credit that also applies to the value of gifts made by an individual during his or her lifetime. That is, if the value of a gift exceeds the annual gift tax exclusion amount, it will reduce your lifetime exclusion. For example, if you give a gift of $20,000 in 2018, it will reduce your lifetime exclusion by $5,000 (the value of the gift less the annual gift tax exclusion).6

Gifting Strategies & Succession Planning

For many business owners, their business is by far their largest asset and represents a significant portion of their estate’s value. When a business owner passes away and leaves their business to a family member, it can result in a significant estate tax liability. Since privately held businesses are illiquid assets, families in such a situation are sometimes forced to sell the business at a significant discount or liquidate the assets to pay estate tax. Fortunately, there are a variety of succession planning strategies that business owners can employ to reduce or minimize their estate tax liability upon death. A common strategy is to gift portions of a business to a child or relative with the expectation that he or she will eventually run the business. Under this strategy, the business owner gifts portions of the business each year at a value below the annual gift tax exclusion. Doing so allows the business owner to pass along complete or partial ownership of their company while reducing tax liability. The increase in the lifetime gift and estate tax exemption from $5.49 million to $11.2 million may benefit some business owners by further reducing the taxable value of their estates. Additionally, business owners who have already maxed out the previous $5.49 million lifetime exemption amount (or are close to doing so) may now be able to continue or accelerate their gifting strategies and further reduce the taxable value of their estates.

The Importance of Planning Ahead

According to a 2017 PwC survey, only about one-third of family business owners have a succession plan in place, while only 23% have a formalized, documented succession plan.7 As we’ve pointed out, these statistics represent potential challenges for many family business owners. There are a variety of estate planning strategies beyond gifting that business owners can explore to ensure their families are cared for and their legacies are preserved after they pass away. You can start developing your succession plan today by meeting with a trusted financial advisor or estate planning attorney to discuss your options. Doing so now rather than later will undoubtedly reduce headaches down the road and help preserve your legacy. 1 2 3 4 5 6 Ibid. 7 This document is for informational use only and may be outdated and/or no longer applicable. Nothing in this publication is intended to constitute legal, tax, or investment advice. There is no guarantee that any claims made will come to pass. The information contained herein has been obtained from sources believed to be reliable, but Mariner Capital Advisors does not warrant the accuracy of the information. Consult a financial, tax or legal professional for specific information related to your own situation.