Equity ownership can provide a path to generational wealth, especially in early- and growth-stage private companies and small businesses. Planning for the short and long-term tax implications of your equity can get complicated, especially if you plan to gift your equity to future generations.
Strategizing for equity transfers can help you optimize the tax-efficient growth of your assets over the long term and avoid adverse tax consequences. In this article, we’ll cover everything you need to know about federal estate taxes and gift taxes for equity.
What you’ll learn:
What are gift and estate taxes?
Gift and estate taxes are types of federal taxes that may be triggered when there is a transfer of property or assets from one person or entity to another. Both types of taxes share the same tax rate and lifetime exemption, meaning that any gifts in excess of the annual exclusion reduce both your remaining lifetime gift tax exemption and estate tax exemption.
The main difference between the two is that estate taxes apply to asset transfers after death, while gift taxes apply to transfers made while both parties are still alive.
While gift taxes are typically paid by the individual making the gift and estate taxes are typically paid by the estate, the recipient of a gift or inheritance will also owe capital gains taxes on the assets when they eventually sell those assets. The capital gain is calculated on a stepped-up basis meaning that the recipient will only owe taxes on the increase in value of the asset from the time the asset was received to when the asset was sold.
The Internal Revenue Service (IRS) defines a gift as “any transfer to an individual, either directly or indirectly, where full consideration (measured in money or money's worth) is not received in return.” Whenever gifts to another individual surpass a certain threshold ($17,000 is the gift tax limit as of 2023), you may be required to report those gifts and file a gift tax return with the IRS.
Filing a gift tax return does not necessarily mean that you’ll owe taxes on gifts. In addition to annual exclusion amounts, there is a lifetime exemption amount that sets the ceiling of the total value of gifts you can give exempt from the gift tax. Per current legislation and as of 2023, the lifetime exemption amount for gifts is approximately $12.9 million.
The gift tax rate is bracketed and ranges from 18% to 40% and applies to the total fair market value of gifts over the threshold of the lifetime exemption amount. So, for example, if you give a gift of $13 million (exceeding the $12.9 million lifetime exemption amount), the excess of approximately $100,000 would be subject to the gift tax.
The estate tax is a taxation of gifted assets that occurs when an individual is deceased. It is also bracketed, ranges from 18% to 40%, and applies to the total fair market value of gifts over the exemption amount ($12.9 million).
Inheritance taxes may also apply to transferred assets—specifically inherited assets—and must be paid by the recipients of those assets. The estate tax is different and distinct from the inheritance tax. While estate taxes are paid by the estate, the inheritance tax is paid by the recipients.
Who owes gift and estate taxes?
Gift taxes are owed by the individuals making the gifts. It’s important to remember that this tax only applies above a certain threshold. Estate taxes are owed by the estate before any of the estate’s assets are passed on through inheritance, also subject to minimum thresholds. In addition to gift and estate taxes, the recipients of the assets may also owe capital gains and inheritance taxes.
Gift and estate tax appraisals for equity
While many giftable assets are liquid and have a value that can be very easily determined (for example, cash or stock held in a publicly traded company), other assets are illiquid and can have a more subjective value that is not as easily determined (such as artwork, real estate, or stock held in a privately held company).
For taxation purposes, the IRS requires a qualified appraisal to establish the fair market value of illiquid assets. When valuing shares in privately-held companies like startups, these appraisals typically apply valuation discounts such as a discount for lack of marketability (“DLOM”) and a discount for lack of control (“DLOC”) to account for characteristics that are typical of minority shareholders in startups, such as the inability to sell one’s shares or control the direction of the company.
When do you need a gift and estate tax appraisal?
You will likely need a gift tax appraisal when you file a gift tax return for any gift of an illiquid asset that exceeds the annual exclusion amount. Gift tax returns for the 2023 calendar year are due either on April 15, 2024, for the standard deadline, or October 15, 2024, for the extended deadline. You also may need multiple appraisals depending on how many gifts you make throughout the year.
Gift and estate tax appraisals at Carta
Carta has experience preparing qualified appraisals for the most common use cases related to gift and estate tax planning:
Gifts: These asset transfers can be made to other individuals and are exempt from the IRS’ gift tax, up to the applicable gift tax exemption amount. This is typically executed as an asset transfer into a trust.
Estate planning: These asset transfers typically occur when a shareholder passes away. Carta’s appraisal services can help you determine the fair market value of any interest held on Carta that is passed on through inheritance to surviving spouses or children and can help you determine whether that transfer may trigger the estate tax.
Donations and charitable contributions: These asset transfers can result in income tax deductions when made to a qualifying tax-exempt organization, such as a charity.
Some of the benefits of working with Carta for estate and gift taxes include:
A seamless client experience
Carta’s transfer valuation services integrate your company’s cap table and 409A valuation, eliminating the need for a stockholder to work with a separate advisor to pass cap table and financial information back and forth (which can lead to bottlenecks and unnecessary errors).
Prepared to meet the IRS’ qualified appraisal requirements
As recently as January 2023, the IRS reiterated the appraisal standards it requires to recognize an appraisal as a qualified appraisal, or an appraisal that the IRS deems as acceptable for gift and estate tax purposes. If an appraisal does not meet the IRS’ qualified appraisal requirements, an individual’s gift tax return may be rejected by the IRS.
Carta’s appraisals are prepared by a qualified appraiser and are prepared to meet the IRS’ qualified appraisal requirements. Our appraisals follow generally accepted appraisal standards as outlined in the Uniform Standards of Professional Appraisal Practice (“USPAP”).
Experienced in both court testimony and IRS audit
Members of Carta’s valuation team have provided valuation-related court testimony and litigation support and have successfully defended clients in IRS audits. Our team has experience supporting clients when the stakes are high and we prepare our valuation policy accordingly to ensure audit defensibility.
No billing surprises
We’ve created a unique pricing model for individuals. We moved away from “billable hours”; instead, our model includes 15 hours’ worth of back-end IRS support as part of your appraisal engagement. If your appraisal is audited or goes to tax court, you’ll likely see substantial savings compared to the hundreds of dollars an hour a third party would charge.
Work with us to plan your strategy
When you meet with Carta’s team, we’ll scope your unique tax and estate planning needs together. We understand that these transfers take time and effort to execute and can approach the timing and delivery of your appraisal report flexibly according to your needs.