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Transfer a Family Business in a Tax-Smart Way

10.31.16 | T&E Chat

If a family-owned business is your primary source of wealth, it’s critical to plan carefully for the transition of ownership from one generation to the next. The best approach depends on your particular circumstances.

For example, if your net worth is well within the estate tax exemption, you might focus on reducing income taxes. If you expect your estate to be significantly larger than the exemption amount, estate tax reduction may be a bigger concern. One excellent strategy to consider in this situation is the use of an intentionially defective grantor trust (IDGT).

An IDGT is an income defective trust. As such, it can be an effective tool for transferring business interests at a minimal gift and estate tax cost.

An IDGT is designed so that contributions are completed gifts, removing the trust assets and all future appreciation in their value from your taxable estate. At the same time, it’s “defective” for income tax purposes; that is, it’s treated as a “grantor trust” whose income is taxable to you. This allows trust assets to grow without being eroded by income taxes, thus leaving a greater amount of wealth for your children or other beneficiaries.

The downside of an IDGT is that when your beneficiaries inherit the business, they’ll also inherit your tax basis, which may trigger a substantial capital gains tax liability if they sell the business. This result may be acceptable if the estate tax savings outweigh the income tax cost.

Questions? Work with us to determine the right strategy to implement when transferring ownership of your business to your heirs. Contact me at SDitman@BerdonLLP.com or your Berdon advisor.

Scott T. Ditman, a tax partner and Chair, Personal Wealth Services at Berdon LLP, advises high net worth individuals and family/owner-managed business clients on building, preserving, and transferring wealth, estate and income tax issues, and succession and financial planning.