Keep it in the family

If your family business declined in value last year, now is the ideal time to pass some of it along to the next generation.

Estate planning is all about tax policy, which makes for uncertain planning given that the estate tax is slated for a one-year suspension in 2010. But it appears that Congress will act this year to freeze the estate tax at its current level. At death a person can pass along $3.5 million tax-free, but anything above that is taxed at rates as high as 45%.

By transferring as much of your business as possible to your heirs while you're still alive, you minimize any estate tax they may have to pay after you're gone. As of 2009 you can give $1 million worth of gifts during your lifetime, tax-free. The amount is cumulative, so you can make the gifts incrementally or all at once. You can also make tax-free gifts of up to $13,000 each to as many individuals as you choose in 2009. That's up from $12,000 last year.

So how does a family business that has declined in value take advantage of the gift-tax rules? It's simple. Right now you can give larger blocks of ownership shares to your children and still stay within the limits. Say your business is worth half what it was a year ago. That means a stock gift worth $13,000 equals twice as many shares as last year's.

If the business appreciates in the future, you'll have picked the perfect time to transfer some or all of the ownership. Your kids will think you're brilliant.

Of course, the IRS imposes detailed rules on these gifts. Tax experts advise having your business assessed by an independent valuation firm before transferring shares.

EnLiten markets novelty items that are sold at the checkout counter at such chains as Walgreens (WAG, Fortune 500) and Wal-Mart (WMT, Fortune 500). Unfortunately, beleaguered consumers weren't in the mood for many impulse purchases in late 2008. The Delray Beach, Fla. company had roughly $1 million in revenues but posted a deep loss. It also got stuck with a warehouse full of unsold doodads.

John Burke, a partner in the business, decided to donate some of the items to charity. During the holidays EnLiten gave 500 Unsound Advice dolls - battery-operated fortunetellers that answer questions with preprogrammed phrases such as "The prospects look good" - to a soup kitchen in Boynton Beach, Fla. Many of the soup kitchen's patrons are recent Latin American immigrants who don't speak English well.

"My company is struggling mightily, and this product didn't exactly fly off the shelves," says Burke. "Unsound Advice helps people new to America learn English phrases. At least we're doing something good with the dolls."

In exchange for donating this inventory, EnLiten will receive a tax deduction equal to the company's original cost. For goods manufactured in-house, the deduction is generally equal to the cost of producing the finished goods. EnLiten's Unsound Advice dolls are manufactured in China at a price of $9 per unit, so EnLiten will get a write-off worth roughly $4,500 for donating 500 dolls.

To claim a donated-inventory deduction, a company must provide goods that a nonprofit organization will actually use. "You could give unsold paper to a school," says Barbara Weltman, author of J.K. Lasser's Small Business Taxes. "But you could not unload a bunch of unsold steel ball bearings on said school."

If you can't find a charitable use for your leftover items, you can dispose of them and claim an abandoned-inventory deduction, which confers identical tax benefits. Take time-stamped photographs that show your goods were, in fact, discarded, says Weltman. In case of an audit, you'll want to show the photos to the IRS.

Finally, the tax experts we consulted said not to worry if you've already filed your 2008 taxes: These tips will all work next year as well. Here's wishing you better fortunes in 2009.  

1 2