Dealer Insights - May/June 2013 - 2013 Might Be A Good Year To Gift Your Dealership
Ah, peace of mind at last. The American Taxpayer Relief Act of 2012 (ATRA), signed into law this past January, finally brought some certainty to estate planning. ATRA makes permanent high exemptions while increasing the top estate tax rate by only a relatively small amount compared to the jump that had been scheduled to take effect this year.
If you have heirs, this newfound assurance — combined with dealership values likely to rise in a healing economy — makes 2013 a logical time to consider gifting ownership interests. But you’ll need to take the following actions before coming to any conclusions.
SIZE UP YOUR TAX POSITION
This year, you can gift up to $14,000 (up from $13,000 in 2012) per individual without incurring federal gift taxes. Unused annual gift tax exclusions can’t be carried forward to future years. But you can gift more tax-free if you tap into your $5.25 million lifetime gift tax exemption.
Your dealership’s appraised value determines how many shares of stock (or partnership units) you may gift tax-free. Any transferred value exceeding your available annual exclusion and lifetime exemption is taxed at federal gift tax rates currently at 40%, or, in the case of a gift to a grandchild or someone else two or more generations below you, a much higher effective rate — because of the generation-skipping transfer tax.
CHECK YOUR DEALERSHIP’S VALUE
When valuing a dealership, business appraisers consider various factors, including:
- Financial performance,
- Market saturation and competition,
- Brand strength, and
- Franchise-imposed transfer restrictions.
General market conditions and the industry outlook also factor into the equation. Auto sales reached a postrecession high of about 14.5 million in 2012, according to automotive information providers Edmunds.com. And auto sales are expected to reach 15 million this year, fueled by an increasingly aging fleet, a host of new models in popular segments, more widely available credit and an expected upswing in the leasing market.
But the auto industry isn’t considered out of the woods yet, mainly because of the slowness of the U.S. economic recovery. The recession resulted in decreased cash flow, increased perceived risks and diminished liquidity, and dealership values haven’t fully recovered. But a lower value means you can transfer a greater percentage of your business with the same gift dollars.
For example, say your dealership was valued (on a controlling, marketable basis) at $5 million before the recession but now is worth only $4 million. At the $5 million value, a 10% interest in your dealership would be valued at $500,000. But, at the $4 million value, a 10% interest would be worth $400,000. Ignoring discounts for lack of control and marketability, the $100,000 valuation differential would lower your gift tax bill by roughly $40,000, assuming the entire gift were taxable at the 40% gift tax rate.
CONSIDER AN FLP OR FLLC
If you’re looking to hand over the reins soon, selling the business outright or directly gifting equity interests may be your best option. But if you want to retain control and gradually bring children into the business, consider a family limited partnership (FLP) or family limited liability company (FLLC).
Under these arrangements, you transfer your dealership to a limited partnership or limited liability company, manage the new entity as general partner or manager-member, and gift limited partner or member units to your heirs. Restrictions on the units limit the recipients’ ability to control the entity’s activities or transfer the units. (If an heir is also employed as a manager of the dealership, he or she may have significant control via the responsibilities of that position — not because of his or her ownership interest.)
Because the FLP or FLLC shares lack control and marketability, they’ll likely be subject to valuation discounts. Although the size of valuation discounts can vary significantly, it’s possible for discounts to reach (or even exceed) 40% of the underlying value of the transferred shares. So, for example, if a 40% combined discount were appropriate, you could transfer a $23,333 FLP or FLLC interest (which would be discounted by $9,333) tax-free to each child under the $14,000 annual exclusion.
SEIZE THE DAY
Although ATRA stabilizes estate tax law by eliminating expiration dates for exemptions and rates, Congress could still pass changes in the future. In particular, there’s been talk of reducing the benefits of FLPs. Consider meeting with your tax advisor to discuss possible 2013 estate planning moves.
Sidebar: Be GRATful for Another Tax Planning Vehicle
Do you plan to gift your dealership to your heirs, but see the appeal of receiving income related to that asset during your retirement years? If so, you might want to consider a grantor retained annuity trust (GRAT), which also can help you minimize gift and estate taxes.
Here, you transfer the dealership — or other assets, such as your dealership’s real property — to an irrevocable trust and name your heirs as beneficiaries. In turn, you receive annual payments over the life of the GRAT. At the end of the GRAT’s term, the trust assets pass to the beneficiaries.
The gift’s value equals the assets’ value less the discounted present value of the annuity payments, as calculated when the gift is made. It’s possible to plan the trust term and payouts to minimize — or even avoid — a taxable gift. (If you die before the end of the trust term, however, the GRAT assets will be includable in your estate.) Legislation reducing the benefits of GRATs has been discussed, so you may want to act soon.
Dealer Insights - May/June 2013 Issue