August 2017

"Giving" The Business With No Tax Cost?

Let's say you have a business and want to transfer some or all of it to your children. You've been told that gifts (during lifetime or at death) over a certain limit incur a tax at a 40% rate. What if you keep your company and your children simply start a competing business? Can you avoid making a large taxable gift by merely having your kids start their own company?

This was essentially the issue in the Bross Trucking company case. Because the father largely ceased operations in his trucking business about the time his three sons opened their new trucking company, the IRS contended that the father had made a substantial taxable gift (at least indirectly) to his sons. The IRS's view was that the intangible value of dad's business (the "goodwill") was distributed from the old company to him and then he gave it to his kids for their new business.

The Tax Court pointed out there are two types of goodwill: personal and corporate. The IRS contended that the company distributed corporate goodwill to Mr. Bross who then gave it to his three sons, which amounted to a taxable gift. However, because of the father's extensive personal involvement in his business, the Tax Court determined the goodwill asset in question was owned by Mr. Bross (i.e., personal goodwill), not by the company. If it was not corporate goodwill in the first place, then the company could not have distributed the goodwill to Mr. Bross and he could not have given corporate goodwill to his sons. Largely because of past regulatory problems, the Tax Court found the company had lost its corporate goodwill. This was a nice victory for the father to have the court determine that no taxable gift had occurred.

The facts of this case are somewhat unique because the trucking company had lost most of its corporate goodwill value through past legal problems that caused an erosion of customer trust, but it is a reminder that there are circumstances where children can enter the "family business" without a transfer of stock that might incur a 40% tax cost.