As you continue to develop your startup business, it’s natural to focus on growth. Business growth can translate into growth of assets. Growth of assets in turn can lead to excessive future taxation.
Keep that in mind as you build both your company’s value as well as your own assets. Remember, it can be easier to plan ahead for taxes than to attempt to strategize after the fact.
Capital gains taxes can skim 35 percent off the top of your earnings or more depending on current proposals before Congress. And in the distant future, estate taxes can snatch 50 percent of assets from your heirs. Keep these tax strategies in mind, so that you aren’t left scrambling at tax time.
Qualified Small Business Stock (GQSBS). Currently, this opportunity excludes federal taxation on qualifying gains, although Congress is currently proposing to reduce this opportunity. There are five requirements. The stock was purchased from a domestic C corporation at original issuance after September 27, 2010; the stock must be in a qualified industry; at least 80% of the value of the corporation’s assets must be used in the conduct of an active business; the stock must have been held for at least five years; and immediately after issuance, the corporation had less than $50 million of aggregate gross assets
Gifting of Stock to a Non-Grantor Trust: This opportunity allows you to gift up to $10 million in stock, or 10 times your tax basis (whichever is greater) to an irrevocable non-grantor trust. And if established correctly in a state such as Nevada or Delaware, assets gifted into the trust can often avoid state taxes as well. Irrevocable non-grantor trusts are typically established for a child, in expectation of passing along family wealth or for such things as paying for college tuition.
Any future gains on the original gifted stock are excluded from capital gains taxation.
Of course, each individual is subject to a lifetime gift tax exemption. These rules create a situation in which you must carefully analyze the benefits and risks of your situation, and time the gifts appropriately under the supervision of a skilled financial professional.
Utilize a parent-seeded trust. A parent-seeded trust provides another strategy for building family wealth while avoiding excessive taxation. The founder’s parents create the trust and then designate the founder as beneficiary. Then, shares of the startup can be sold to the trust, where they are held in expectation of future growth.
These shares are not eligible for GQSBS exclusions, but because the transfer involves a sale, it does not count toward the lifetime gift exemption. And because assets are moved to a trust, they are not subject to future estate taxes.
Grantor-retained annuity trust (GRAT). For founders who have already used up their lifetime gift tax exemption, a grantor-retained annuity trust can provide a powerful strategy. A GRAT can be used to transfer assets outside of your estate, while allowing a return of steady annuity payments.
Intentionally defective grantor trust (IDGT). Like the GRAT strategy, an IDGT allows you to transfer assets outside of your estate and into a trust. But with this maneuver, you must seed the trust with 10 percent of the asset value to be transferred. Therefore, the IDGT method will affect your lifetime gift tax exclusion. Then, the remaining 90 percent of the transferred value is sold to the trust in exchange for an interest-only note. The sale is not subject to capital gains or GQSBS taxes. An IDGT can be more flexible than a GRAT, and allows you to skip generations, avoiding generation-skipping transfer taxes.
Before attempting any of the above strategies, a startup founder must evaluate their current position and long-term goals. Tax planning after the fact can be next to impossible, so time is of the essence when considering tax reduction strategies. Discuss your concerns and issues with your business planning attorney and financial professionals in order to develop a plan that works best for your situation.
