Help Business Owners Play Beat the Clock
Alarm clocks kill dreams. And they strike without warning. Alarm clocks are ticking for millions of family-owned businesses in the United Statesmany of them S Corporationswhose owners plan to pass their companies to their children. If these business owners fail to take the right planning steps, die prematurely or both, the alarm will sound on their dreams of transferring their business to the next generation.
You can help your clients who own small businesses to silence these alarms before they ever sound. You can do so in part by employing an increasingly popular planning technique, the Grantor Retained Annuity Trust. A GRAT can reduce capital-depleting gift and transfer taxes that can make it financially prohibitive to pass a business to the next generation.
A GRAT can also generate a steady stream of income for the business owner. Your client can accomplish these objectives by establishing a GRAT with help from a qualified attorney.
GRATs are especially popular with S Corps, limited liability corps and other closely held businesses with steady profits, particularly those with large real estate holdings. Because IRS regulations clearly define the tax treatment of GRATs, advisors increasingly see the vehicle as an alternative to Family Limited Partnerships (FLPs) for passing assets to future generations.
To illustrate the GRATs value, consider the example of Fred, president of Rent Properties, a $5 million, closely held real estate business that owns and manages apartment buildings. Fred, 55, and his wife, Ethel, want to transfer the business, established as an S Corp, to their daughters, Kelly and Melanie, in 15 years.
Fred places $4 million of RPs stock, which amounts to 80% of his business, in a GRAT. During the next 15 years, the GRAT will generate $300,000 a year (at a hypothetical 7.5% annually).
Using the applicable federal rate or AFR (determined by consulting an IRS table) of 4.6%, Freds gift to his children is approximately $1 million, which uses his applicable gift tax exclusion amount. After 15 years, the GRAT dissolves and 80% of Rent Properties passes free of gift taxes to both Kelly and Melanie.
How so? The longer Fred holds the GRAT and the more income he receives from it, the smaller the value of the business for gift tax purposes.