Ways To Reduce or Eliminate Gift-Tax Liability

My son graduated recently from dental school and I would like to transfer the practice to him. I am planning to give him the practice without charge and, if possible, would like to do this without any cash changing hands. If I do this, will he have to pay a gift tax? Are there any other alternatives that you would recommend?

Jan 1st, 1997

Charles Blair, DDS and

John McGill, MBA, CPA, JD

Question:

My son graduated recently from dental school and I would like to transfer the practice to him. I am planning to give him the practice without charge and, if possible, would like to do this without any cash changing hands. If I do this, will he have to pay a gift tax? Are there any other alternatives that you would recommend?

Answer:

It is possible to simply gift the assets of the practice to your son over time, without any cash trading hands. However, the transaction would be subject to federal and state gift taxes.

We have two recommendations to reduce or eliminate the gift-tax liability on the proposed transaction. First, we would recommend that you incorporate your practice prior to making the gifts, so that you will be gifting shares of stock. A transfer of stock includes a transfer of assets as well as liabilities, so that the net amount of debt included in the corporation would reduce the amount otherwise treated as a gift. In addition, we would recommend making gifts of these share of stock over several years, rather than at once.

Under current gift-tax laws, you are able to exclude $10,000 per donee per year from gift taxes, using your annual exclusion. In addition, if you are married, you and your wife can make a split-gift election on the federal gift-tax return when filed (Form 709), which allows you to use her $10,000 exclusion, even though all of the shares of your professional stock are owned by you. By doing so, you are able to double the annual exclusion to $20,000 per year.

By making gifts over several years, each gift will constitute a minority-ownership interest in the practice. As such, the Tax Court and the IRS recognize that the value of a minority interest in a business must be discounted from its face value to determine its true fair-market value. Acceptable discounts have ranged from 30-60 percent in Tax Court cases, although most fall in the 30-40- percent range. Accordingly, you probably could increase your annual gifts to around $30,000 a year and still pay no gift tax, through utilizing the minority-interest valuation discount, split-gift election and annual gift-tax exclusion.

Another alternative is even better. Your son would establish a new professional corporation in which he would own 100 percent of the stock from inception. At that point, you would retire and your patients would be free to move to any practice they chose. Since your son`s corporation would be practicing in the same location, and would be simply subleasing space from your corporation, most, if not all of the patients simply would elect to transfer to his corporation. Thereafter, all patient files, records and charts would be moved to his corporation as these patients transfer. His corporation would commence practice, would order all supplies and inventory and would sublease the real estate and lease the equipment from your existing corporation.

Approximately one year later, you could plan to begin gifting the shares of stock in your professional corporation to him, and thereafter he simply could merge the two corporations together.

In the first approach outlined above, the value of the corporate stock would include the value of the entire practice, composed of both tangible and intangible assets. This would be roughly the same price as if you sold the practice as a going concern to a new dentist. On the other hand, under the second approach there would be no goodwill value to transfer, since you would have retired, and most, if not all, of the patients would have elected to transfer to your son`s corporation.

Accordingly, for gift-tax purposes, the value of the share of stock that you ultimately would gift to him would be substantially reduced, since the only corporate assets with value would be the value of dental and office equipment and supplies and instruments owned by your corporation. We would recommend the second approach.

I have been named the executor of my father`s estate. About a year prior to his death, he transferred the ownership and beneficiary of several life insurance policies, worth approximately $500,000, into an irrevocable life-insurance trust. My accountant now tells me that these policies must be included in his taxable estate. Is he correct?

He is. While transfers by gift generally are not included in the donor`s taxable estate, an exception applies with respect to certain transfers of insurance policies.

Under Section 2042 of the Internal Revenue Code, transfers of insurance policies made within three years of death are brought back into the transferor`s taxable estate upon death. Despite this, your father will not owe any estate tax if his net taxable estate is $600,000 or less, if single. If he was married at his death, he would be eligible for a marital deduction equal to the amounts provided to his surviving spouse, which also could eliminate any estate tax liability.

It is recommended that you contact your tax adviser before undertaking any tax-related transaction.

Dr. Blair is a nationally-known consultant and lecturer. McGill is a tax attorney and MBA. They are the editors of the Blair/McGill Advisory, a monthly newsletter helping dentists to maximize profitability, slash taxes and protect assets. The newsletter ($130 a year) and consulting information are available from Blair/McGill and Company, 4601 CharlottePark Drive, Suite 230, Charlotte, NC 28217, phone (704) 523-5882.

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