Limited time opportunity: Take advantage of the expanded unified gift and estate tax exemption
October 20, 2023
The Tax Cuts and Jobs Act (TCJA) effectively doubled the unified federal gift and estate tax exemption — and inflation has boosted it even further. For individuals who make gifts in 2023 or die in 2023, the unified exemption is $12.92 million (effectively $25.84 million for married couples). This is an increase of $860,000 per person from 2022! Unfortunately, the expanded unified exemption is scheduled to revert to pre-TCJA levels after 2025, unless Congress extends it.
It’s uncertain what will happen with the tax code in the future. But private business owners should consider transferring ownership to the next generation or their favorite charities now — while the tax laws are favorable and business values are down because of uncertain market conditions.
Gift and estate tax basics
Under the TCJA, the federal gift and estate tax exemption per individual increased from $5 million to $10 million, with annual indexing for inflation. Taxable estates that exceed the exemption amount now have the excess taxed at a flat 40% rate.
In addition, cumulative lifetime taxable gifts that exceed the exemption amount are now taxed at a flat 40% rate. Taxable gifts are those that exceed the annual federal gift tax exclusion, which is $17,000 for 2023. If you make gifts in excess of what can be sheltered with the annual gift tax exclusion amount, the excess reduces your lifetime unified federal estate and gift tax exemption dollar-for-dollar.
Under the unlimited marital deduction, transfers between spouses are federal-estate-and-gift-tax-free. But the unlimited marital deduction is available only if the surviving spouse is a U.S. citizen.
If you make gifts of business interests to family members, loyal employees or charities today, the fair market value of those gifts may count toward your lifetime exemption — which means they would be tax-free.
For example, suppose an unmarried business owner gifts private stock to 10 family members valued at $1.17 million in 2023. After the annual gift tax exclusion is applied to $170,000 of gifts, the lifetime exemption can shelter the remaining $1 million from gift tax. That leaves an available estate tax exemption of $11.92 million (assuming the business owner hadn’t tapped into the lifetime exemption in a previous year).
Important: Some states impose estate or inheritance tax at a lower threshold than the federal government does.
Value of gifts
How much is a company’s stock worth today? This question needs to be answered before business owners can make gifts or donations. The answer tells how much stock can be gifted without incurring gift tax — or how much can be deducted for a charitable donation. And it helps owners formulate a long-term strategy for transferring wealth.
For gift and estate tax purposes, IRS Revenue Ruling 59-60 identifies the following eight factors to evaluate the fair market value of a private business:
1. Its nature and history,
2. The outlook for the industry and economy,
3. The company’s book value and financial condition,
4. Its earnings capacity,
5. How much dividends the company could (or does) pay out,
6. The value of goodwill and other intangible assets,
7. Prior sales of the company’s stock and the size of the block, and
8. The price paid in comparable stock transactions.
In addition, smaller ownership interests may be eligible for discounts for lack of control and marketability.
Do-it-yourself business valuations may raise a red flag. So, most taxpayers hire a business valuation professional to estimate value. Valuation experts use real-world empirical data to support their analyses, rather than gut instinct or industry rules of thumb.
Moving target
Volatile market conditions have adversely affected the values of businesses in many industries. Another reason to gift (or donate) business stock sooner rather than later is that it tends to appreciate in value over time. Proactive gifting strategies allow owners to transfer business interests during their lifetimes, while values are relatively low. This exposes less of their net worth to estate tax. Contact a business valuation professional to help formulate effective gifting and charitable-giving strategies for your business clients.