Gift Tax Planning for Entrepreneurs

Gift tax planning for entrepreneurs: why timing matters

Gift tax planning allows entrepreneurs to transfer wealth and company shares to the next generation during their lifetime at a lower overall tax cost than a transfer on death. German inheritance and gift tax are governed by the same statute, the Inheritance and Gift Tax Act (ErbStG), with the same rates and largely the same reliefs.

The key advantage of lifetime gifts lies in the personal allowances: they are renewed every ten years, so that a plan spread over decades can transfer substantial values tax-free. In addition, gifts can be made when values are low, before the business grows, and with reserved rights such as a usufruct that keep income and control with the founder. Gift tax planning also gives the family time to prepare successors and to structure the business for business-asset relief.

This article explains, from a practical perspective, the personal allowances and ten-year rule, the tax rates, the use of reserved usufruct, staged transfers of company shares and the main pitfalls for entrepreneurs.

Allowances and the ten-year rule

Each recipient has a personal allowance (Freibetrag) depending on his or her relationship to the donor. Under § 16(1) ErbStG, the allowances for donees with unlimited tax liability are EUR 500,000 for a spouse or registered partner, EUR 400,000 for each child, EUR 200,000 for each grandchild, EUR 100,000 for other persons in tax class I, such as great-grandchildren, and EUR 20,000 for persons in tax classes II and III, such as siblings, nephews, nieces and unrelated persons.

All gifts from the same person to the same recipient within ten years are aggregated (§ 14(1) ErbStG): earlier gifts are added to the latest gift at their earlier values, and the tax on earlier gifts is credited. After ten years, the allowance is available again in full. A parent can therefore give each child EUR 400,000 tax-free every ten years, and both parents can do so separately, so that two parents can transfer EUR 800,000 to each child every decade without gift tax. Over thirty years, the allowances alone allow transfers of EUR 2.4 million per child from two parents.

The rates rise progressively with the value of the taxable acquisition (§ 19(1) ErbStG): in tax class I from 7% to 30% for amounts above EUR 26 million, in tax class II from 15% to 43%, and in tax class III 30% or 50%. Because the rate applies to the entire taxable amount within a bracket, spreading gifts over several ten-year periods also keeps the applicable rate lower.

Reserved usufruct and other retained rights

Entrepreneurs often want to transfer ownership while keeping income and influence. The classic instrument is a reserved usufruct (Vorbehaltsnießbrauch): the donor transfers shares or real estate but retains the right to the income for life or a fixed period. For gift tax purposes, the capitalised value of the usufruct reduces the taxable value of the gift, so that the recipient is taxed only on the remaining value. The longer the expected duration of the usufruct, the higher the deduction, which makes early gifts with a usufruct particularly efficient.

For company shares, the usufruct must be designed carefully. For partnership interests, the recipient must become a co-entrepreneur (Mitunternehmer) with sufficient participation in profits and decision-making for the gift to qualify for business-asset relief and for income tax neutrality. If the founder reserves too many rights, the recipient may not be treated as a co-entrepreneur, which can lead to a loss of relief or adverse income tax consequences. For GmbH shares, voting rights can be retained through the usufruct or through separate arrangements, but the economic and tax consequences differ.

Other retained rights include rights of revocation, which allow the donor to reclaim the gift in defined cases, such as the recipient's insolvency, divorce or death before the donor, or a breach of agreed restrictions. If a gift is returned because of a contractual right of revocation, the gift tax lapses retroactively (§ 29(1) no. 1 ErbStG). Well-drafted revocation clauses therefore offer protection without tax cost.

Staged transfers of company shares

For entrepreneurs, gift tax planning usually focuses on shares in the family company. Business-asset relief under §§ 13a and 13b ErbStG applies to gifts as it does to inheritances, with an exemption of 85% or 100% subject to the wage sum, holding period and administrative asset rules; see our article on inheritance tax relief for business assets. Lifetime transfers allow the family to control the timing: the business can be restructured to reduce administrative assets, the valuation can be timed for a moment when earnings are lower, and transfers can be split to stay below the EUR 26 million threshold over the ten-year aggregation period.

Staged transfers typically follow a pattern: first, minority stakes are transferred to children with reserved usufruct and revocation rights, while the founder retains control through voting rights or management positions; later, majority control passes as the successors take on responsibility. Each step should be coordinated with the articles of association, which should restrict transfers to family members, provide for redemption in case of insolvency or divorce, and contain the restrictions needed for the family company discount if desired. Pooling agreements may be needed to qualify holdings of 25% or less for relief.

Illustration: an entrepreneur owns 100% of a GmbH worth EUR 8 million. She transfers 20% to each of her two children with a reserved usufruct over the dividends and a revocation clause. With business-asset relief, the gift tax on each transfer is low, and the allowance of EUR 400,000 per child covers most of the remaining taxable value. Ten years later, when the children manage the company, she transfers the remaining 60%, again using renewed allowances.

Real estate, the family home and other assets

Gifts of real estate are exempt from real estate transfer tax (§ 3 no. 2 of the Real Estate Transfer Tax Act), which makes property a common object of lifetime gifts, often with reserved usufruct or a right of residence. The transfer of the family home between spouses during their lifetime is exempt from gift tax regardless of value, if the property is used as their own residence (§ 13(1) no. 4a ErbStG). Transfers of the family home to children are exempt on death only under strict conditions, which is a further reason to consider lifetime solutions. Gifts of cash and securities are straightforward but do not benefit from relief beyond the allowances.

Real estate held in a company may qualify for business-asset relief only in limited cases, because let property is generally an administrative asset. Families with large property portfolios should therefore consider separate structures and the timing of gifts, as well as alternatives such as a family foundation; see our article on family foundations in Germany.

Valuation, returns and procedure in gift tax planning

Gift tax is assessed on the value of the gift at the date it is made. Shares in non-listed companies and business assets are valued under the Valuation Act, using prices from sales to third parties within the past year, a recognised earnings-based method or the simplified capitalised earnings method, but never below the net asset value. Real estate is valued by statutory methods that approximate market value; taxpayers can prove a lower market value with an expert opinion. Because the valuation determines the tax, gift tax planning should start with a realistic valuation and, for larger transfers, an independent expert report.

Every gift must be notified to the tax office within three months, by both donor and recipient, unless it was notarised, in which case the notary informs the tax office. The tax office then requests a gift tax return. Both donor and donee are liable for the tax; in practice, the donor often agrees to bear it, which is itself an additional gift added to the taxable value. Where business-asset relief is claimed, the tax office separately determines the value of the business and the administrative assets, which can take time and lead to disputes.

International gifts

German gift tax applies if either the donor or the recipient is resident in Germany at the time of the gift, and German nationals remain subject to unlimited liability for five years after moving abroad. For non-residents, limited liability applies only to specific German assets such as real estate and business assets. Because Germany has inheritance tax treaties with only a few countries, cross-border family structures must check foreign gift and inheritance taxes and the possibility of crediting them, and should coordinate gift tax planning with the rules on exit taxation discussed in our article on exit taxation.

Pitfalls in gift tax planning

• Chain gifts: passing a gift from one spouse to the other and then to a child, to use the spouse's allowance, can be disregarded if the intermediate recipient had no real freedom of decision.
• Hidden gifts: below-market sales, interest-free loans or disproportionate profit allocations to family members can be taxable gifts.
• Income tax: gifts of shares in corporations are not taxable disposals, but gifts of business assets must be structured to avoid realising hidden reserves.
• Compulsory portions: gifts within ten years before death can trigger supplementary compulsory portion claims by other heirs, reduced by one tenth for each year (§ 2325(3) BGB); see our article on wills and inheritance contracts.
• International aspects: where donor or donee lives abroad, foreign gift or inheritance tax may also apply, and Germany has few inheritance tax treaties.

How TRW & Co helps with gift tax planning

We advise entrepreneurs and families on gift tax planning: multi-year transfer plans using allowances, reserved usufruct and revocation clauses, staged transfers of company shares with business-asset relief, real estate gifts and coordination with wills, marital agreements and articles of association. We prepare gift agreements, gift tax returns and applications for relief and represent clients in disputes with the tax authorities. Our succession planning team can be reached via our contact page. This article provides general information and is not tax or legal advice.