Smart Gifting of Company Stock

Many marketers are receiving terrific tax benefits from gifting company stock to children at the urging of their tax-savvy attorneys and CPAs. A well-planned giving program over even a few years can work wonders for your estate.

Per current IRS regs, a married couple can give each child (or any individual for that matter including a key employee) $22,000 worth of stock each year and have no tax ramification. (A single marketer would be limited to $11,000 per child or employee.) So, with three children, even a short five-year giving plan would transfer $330,000 from a couple to their children tax-free. Stretch this out to a fifteen-year plan and that number jumps to almost $1 million!

Because of new IRS rules about stock value in gifting, we’ve been getting calls at Meridian about providing gift tax supporting valuation documentation. The first question is usually whether a valuation is really needed. The short answer is absolutely yes if you exceed the $11,000 per person exception amount. Even within the exception amount, most CPAs recommend you attach a valuation. Why? 

Because the IRS requires you use the Fair Market Value of your stock as basis. IRS Regulation 20.2031-1 defines this value:

“The fair market value is the price at which the property would change hands between a willing buyer and a willing seller, neither being under any compulsion to buy or to sell and both having reasonable knowledge of relevant facts. The fair market value of a particular item of property includible in the decedent’s gross estate is not to be determined by a forced sale price. Nor is the fair market value of an item of property to be determined by the sale price of the item in a market other than that in which such item is most commonly sold to the public, taking into account the location of the item wherever appropriate.”

Gone are the days of using simple book value! Of course, we’ve been doing market valuations at Meridian for years so this type of supporting valuation is normal course of business for us. This makes perfect sense in our minds.

The next question we are asked pertains to discounting for minority interests. Usually when parents gift, the kids end up with minority share positions. Discounting gets a little tricky so here is what the IRS says in their Form 790 Gift Tax Return Instructions:

“If the value of any gift you report in either Part 1, Part 2, or Part 3 of Schedule A reflects a discount for lack of marketability, a minority interest, a fractional interest in real estate, blockage, market absorption, or for any other reason, answer “Yes” to the question at the top of Schedule A. Also, attach an explanation giving the factual basis for the claimed discounts and the amount of the discounts taken.”

Since Meridian has no such factual information on fractional or minority sales in our extensive database (because frankly there are almost none in the industry!) we do not get involved with discounts. Instead, we leave minority discounting up to IRS-savvy CPAs and tax attorneys. We provide you with your market valuation, and then, at your CPA or tax attorney’s discretion, they can work their magic with supportable discounts. Your tax professional should have extensive knowledge of generic non-petroleum company discounts (since there is no petroleum industry data). Just be sure whoever you select for your discounting will stand behind their figures with supportable data.

Also, don’t be surprised if your CPA balks when you mention using Meridian for your valuation work. With fees ranging typically from $7,500 to $15,000 per corporate entity, we have found many CPAs very unhappy to lose that piece of business to an outside entity like Meridian. When presented with the facts about our industry-specific knowledge and database, however, most will politely take a back seat. It’s always good to remember you are the customer when you want a quality, accurate number.

The third and usually final question we get is related to any downsides or risks in pre-death share transfer. For companies that do not have voting and non-voting classes of stock, one downside risk is your children instantly become voting stockholders. For this reason, we definitely recommend keeping an eye on the number of shares required to maintain majority ownership unless you are prepared for a potential family coup! Another solution to this problem is to split your shares into two classes, voting and non-voting and only gift the non-voting.

Another downside to consider before gifting is potential inadvertent changes in stock ownership. For instance, one of your children might marry and then later end up in a nasty divorce. Carefully crafted buy-sell agreements can prevent future sons and daughters-in-law access to previously gifted shares. These buy-sell agreements can be powerful tools for gifting shares to key employees as well. You wouldn’t want a terminated employee maintaining your shares!

Gifting is a smart tax strategy, but one that should be done with complete and thorough due diligence. Seek your attorney’s counsel for protecting the well being of you and your company both now and after gifting!

PetroAnswers Smart Gifting of Company Stock