Tax Consequences of Giving a Business to a Family Member

When small businesses are family enterprises, it is common for an elder generation to gift the business to their children. These types of gratuitous transfers are taxable to the donor either by the estate or gift tax. When transferring the business, it is important to establish the recipient’s tax basis in the property for when it is sold in the future and to inform the IRS as to who is currently running the business.

Estate and Gift Tax

  1. Property that is transferred to an individual for free or for less than fair market value (FMV) with a donative intent is taxed under the gift and estate tax. The gift tax applies if the gift is made while the donor lives and the estate tax if the bequest is made after the donor’s death. For gift purposes, only the excess of the FMV of the donated property over the amount of compensation received for the property is what is taxable. FMV is how much the property would get on the open market if it were sold in a non-compulsory sale. For gifts given to an individual, only those gifts that exceed $13,000 (or $26,000 if jointly given by yourself and a spouse) are taxable in any given year. As a result, if you are planning to give a business to a relative, it may be a good idea to do so over time to minimize expense. For estates, only those with assets in excess of $5 million are taxed. If your estate is in excess of that amount, consider distributing some of the business ownership through gifts over a period of time to minimize your tax burden.

Recipient's Basis

  1. Basis is the measure of an individual’s after-tax investment in property. Basis is an important tax consideration because when the property is sold in the future, the taxpayer’s basis in the property is subtracted from the proceeds to determine taxable gain or losses. In you receive the business as a gift and its FMV at the point of transfer is equal to or greater than the donor’s basis in the business, your basis in the business is the same as the donor’s when he transferred the property, plus how much the donor paid in gift tax. If the donor’s basis is greater than the FMV of the business when it is gifted, your basis depends on whether you ultimately sell the property for a gain or a loss. If you sell the business for a gain, you use the donor’s basis; if it is for a loss, use the FMV of the business at the time it was donated. If you received the property as an inheritance, your basis in the property is equal to the FMV of the property as of the date of the decedent’s death. .

Employer Identification Number

  1. An Employer Identification Number (EIN) is how the IRS identifies businesses for tax purposes and is the equivalent of an individual’s Social Security number. If your business has been in existence for a while, it should already have one. However, the IRS requires a business to obtain a new EIN whenever ownership changes. Once the exchange is made, be sure that the new owner applies for a new EIN.

Tips and Disclaimer

  1. When completing a transfer of business ownership, consult with a licensed attorney in your area to ensure that everything is done in accordance with state law. While completing personal or gift tax returns, consult with a certified public accountant to ensure proper filing. Every effort has been made to ensure this article’s accuracy, but it is not intended to be legal advice.