“Blood may be thicker than water,” begins an advertisement in a recent edition of the NY Times Magazine, “but can it hold a business together?”   The advertisement continues, “It’s a little-known fact that nearly 90% of U.S. businesses are family firms. All over America, people pour their heart and soul into building family companies. Unfortunately, few put that same passion into preparing for the next generation to take over, although most say that’s their wish.” It concludes, “ And sadly, due largely to that lack of succession planning, by the third generation a paltry 12% of family businesses remain family controlled.”

In the first blog post of this series, we considered some of the issues that a parent faces in determining the disposition of his or her business among family members. In the second post, we assumed that the parent has decided that the business should be kept in the family, and we considered the conceptual groundwork for the parent’s transfer of interests in the family business to his or her children. Now we turn to the various means by which these transfers may be effected.

Transfer Vehicles

Assuming that the estate tax benefits of gifting outweigh the economic and income tax benefits of retaining the business interests, the following describes some of the vehicles that may be utilized.

Straight Gift

The simplest form of gift is a straight transfer of property that is made without consideration. Such a transfer may be made either outright to a child, or in trust for the benefit of the child (and/or the child’s family). The amount of the gift is the FMV of the business interest (either a voting or nonvoting interest) on the date of the transfer.  (Note: an outright transfer of a business interest should be preceded by the parent’s adoption of a shareholder’s or operating agreement, and the admission of the child as an owner should be contingent upon the child’s agreement to be bound by the terms thereof.) If the transfer is made in trust for the benefit of the child and the child’s family (including the grantor’s grandchildren), some of the grantor’s GST exemption amount may be allocated to the trust so as to protect future trust distributions from GST tax.

To start with some gifting basics, a parent can make annual gift transfers totaling up to $14,000  ($28,000 with the consent of the parent’s spouse) to each of his or her children (or to a trust for the child’s benefit), without such transfers being treated as taxable gifts. In other words, so long as the total value of property transferred by gift (including a business interest) to a child in a single tax year does not exceed $14,000, the parent will not exhaust any of his or her gift tax exclusion amount.  This form of gifting remains the simplest way of transferring business interests to a family member free of gift tax.

Instead of making yearly gifts limited to the annual exclusion amount, the parent may decide to make an outright gift of a larger value that represents a greater percentage of the equity in the business. There are any number of reasons why this may be sensible from a tax perspective.

Closely-held entities are difficult to value, and the IRS will often challenge the reported value for such an entity as well as the size of the discount for the transferred interest (even where both are well reasoned and supported by a professional appraisal – which should always be the case), depending upon a number of factors.  The result is often a compromise or settlement somewhere between the value reported by the parent-taxpayer and that asserted by the IRS.

With the increased exclusion amount, however, any adjustment by the IRS may be less likely to impact the ability of many taxpayers to make such gifts free of gift tax; this, in turn, should give taxpayers more freedom to make annual gifts, or gifts of greater amounts, with respect to hard-to-value business interests.

Grantor Trust

Transfers in trust may also provide an opportunity for leveraging the gift made by the parent-taxpayer and for further reducing the parent’s taxable estate, depending upon the terms of the trust.

A trust is, generally speaking, a taxable entity.  In the case of a so-called grantor trust, however, the parent-grantor who has made a completed gift into the trust continues to be treated as the owner of the trust assets for income tax purposes; thus, the trust’s income and gain are both taxable to the parent notwithstanding the fact that he or she does not have a beneficial interest in the trust.  (For a discussion of trusts as shareholders of an S corporation, see our earlier post here.)

Consequently, the trust property is allowed to appreciate without being reduced by any income taxes. Moreover, there is an added benefit of the parent-grantor’s estate being further reduced by his or her payment of the income taxes attributable to the trust property.  Additionally, this payment of taxes is not treated as a taxable gift by the grantor to the trust.

Of course, there are risks associated with grantor trusts in that the income tax liability generated to the parent-grantor can be relatively substantial, especially with the increased federal rates for ordinary income (39.6%) and capital gains (20%), plus the new surtax (3.8%) on net investment income.

In addition, it is imperative that the parent be careful in structuring the grantor trust so that he or she has not retained any interests, rights or powers with respect to the trust property (the transferred business interest) such that the trust would be included in the parent’s gross estate (for example, a right to income or to control beneficial enjoyment).


A parent who wants to receive some revenue stream from the business interest may want to consider a form of transfer which provides some “consideration,” rather than an outright gift.

There is a statutorily-approved means of transferring property to one’s beneficiaries, while retaining an interest in the property, and also reducing the amount of the gift: the GRAT (or grantor retained annuity trust).  GRATs allow the transfer of future appreciation in contributed property, generally without any estate or gift tax charged on the growth of that property.

They are irrevocable trusts to which a parent may contribute property (such as a business interest which is expected to appreciate in value), while retaining the right to receive an annuity (a fixed amount, typically based upon a percentage of the FMV of the business interest initially contributed) from the trust for a term of years.  At the end of the term, the business interest passes to his or her family, or the trust continues for their benefit (possibly as a grantor trust).

The term of the trust (specifically of the parent’s annuity interest) should be such that the parent will survive the term; if he or she dies during such term, the retained annuity interest will cause at least part of the trust to be included in the parent’s gross estate for estate tax purposes.

The annuity is paid out of income, and then corpus, and it may be paid in kind, including from the contributed property. Thus, some portion of the contributed business interest may be returned to the parent; however, if the interest has appreciated during the GRAT term, that appreciation passes to (or for the benefit of) the children.

It should be noted that, in order to make the required payments to the parent-grantor, ideally the GRAT should receive distributions from the business in which it owns an interest. For this reason, S corporation shares or membership interests in LLCs/partnerships are good candidates for GRATs; in general, these entities are not subject to an entity-level income tax, and cash distributions to their owners are generally not taxable. (Absent such distributions, the GRAT will have to make an in-kind transfer to the parent-grantor.)

For transfer tax purposes, the retained annuity interest represents consideration for the contribution into the trust and, so, reduces the amount of the gift. Specifically, the amount of the gift is equal to the FMV of the business interest contributed to the GRAT by the parent over the actuarially-determined present value of the parent’s retained annuity interest.

The receipt of the annuity interest, however, does not cause the transfer of property to the trust to be taxable to the parent, as a sale of the business interest for income tax purposes, because a GRAT is structured as a grantor trust– that is to say, its assets are deemed to be owned by the parent-grantor.  (See our earlier post about legislative proposals aimed at GRATs here.)

If properly structured, the amount of the gift can be minimal; in other words, the present value of the annuity may be nearly equal to the value of the interest contributed to the trust. This allows the parent’s exclusion amount to remain largely intact and available for other gifting, or to protect transfers at death.

In addition, with a short enough annuity term, the parent-grantor is likely to survive the term of the annuity and, so, the trust property, and the appreciation thereon, are likely to avoid being included in the parent’s estate.  At the end of the annuity term, any property remaining in the trust (that has, hopefully, appreciated) passes to the family free of gift tax and estate tax.

All of these benefits are compounded by the fact that the GRAT may be treated as a grantor trust during the term of the parent’s retained annuity interest for purposes of the income tax; thus, its income is taxable to the parent-grantor, allowing the trust to grow further while simultaneously reducing the parent’s estate.   The trust can even continue after the annuity term expires, further leveraging the grantor trust status (by causing the parent to continue to be taxed on the trust income), reducing the parent’s estate, and maybe providing other benefits (like asset protection) for the family.

One day, all of this shall be yours.

For purposes of the above discussion, we have assumed that the parent’s transfer of an interest in the business made sense from both a tax and a business perspective. Implicit in this assumption is the further assumption that the parent’s successor, from within the family, has been chosen. That may not always be the case. What if two of the children are involved in the business, neither one of which has ultimately emerged as the natural successor?  Unfortunately, under those circumstances, there may not be an easy solution, and there are many options to be considered (whether in the framework of a trust, shareholders’ agreement, or otherwise). The bottom line: the parent should not shy away from addressing the tough issue – kicking the can down the road should not be an option. It will ultimately benefit the business and the family if the parent discusses the issue with his or her advisors now.


The foregoing reflects some of the gift-related methods by which interests in the family business may be transferred to children.  Some are more basic than others, and each may be tailored to address a specific requirement or concern to the parent.  The point is that it behooves the parent to discuss the options thoroughly with his or her advisors before directing that a particular gift transfer be made.

Keep an eye out for our next blog post, where we’ll consider various “non-gift” techniques for transferring interests in the family business.