For many entrepreneurs and family business owners, the legacy and wealth they have worked so hard to build has long been threatened by the federal estate tax. Without proper planning, families can see up to 45% of their assets go to Uncle Sam rather than their intended beneficiaries (in some cases, certain assets can be subject to multiple levels of taxation totaling almost 75% once you consider federal estate and income tax as well as state inheritance taxes).
During the Bush administration, the federal estate tax was repealed starting in 2010, but only for one year, and is set to return in 2011 (Economic Growth and Tax Relief Reconciliation Act of 2001). Time and time again I am asked by my clients whether I believe the repeal will actually take place in 2010. Additionally, there are changes to various aspects of estate taxation that are being considered by the current administration.
The most recent research suggests that the federal estate tax only affects 1% of the general population. Essentially, the "un-lucky few" subject to the tax are an easy target as politicians spin things to make it seem like the tax only affects those who can afford to pay it! When we consider the general theme of the current administration's tax policies, it would seem they would be reluctant to give up the revenue that the estate tax generates
Furthermore, on May 11th the Treasury Department issued a report entitled General Explanations of the Administration's Fiscal Year 2010 Revenue Proposals, aka the "Green Book". In the report, the temporary solution for the estate tax is to extend the 2009 exemption amounts and rates through 2010. This would mean that the exemption amount would remain at $3.5 million and the top rate would stay at 45% for 2010. Most estate planners are planning for similar levels to stay in place for 2011 and beyond. Bottom line… the estate tax isn’t going away!
So where do we go from here? We start planning! Family business owners who have accumulated substantial wealth need to sit down with their advisors to start planning to pass their assets and value on to the next generation. For those who have already created an estate plan, be certain to review that plan to ensure it still accomplishes your goals and objectives. Even in a few short years many things can change that will make an estate plan ineffective (i.e. legislative changes, family changes, economic factors
In light of the current recession, I am seeing lower values for business and real estate. This would make now a great time to start transferring assets to ensure the wealth you worked so hard to create is preserved for your intended beneficiaries
Look for Family Business Owners and the Estate Tax – Part 2 in the coming weeks
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Scott:
One way to drastically reduce estate/gift taxes on the transfer of closely held Company stock, is to sell a portion of the Company to an ESOP in a leveraged transaction (i.e., the Company borrows money and lends it to the ESOP; the ESOP uses the money to purchase a portion of the Company stock).
In addition to providing liquidity to the selling shareholder, this transaction reduces the tax cost of transfering the remaining stock because the debt taken on by the Company reduces the stock value (temporarily, as long as the debt remains outstanding) dollar-for-dollar.
For example, if a Company is worth $10MM, the federal estate/gift tax on transfer would be approximately $2,925,000 (45% of $6.5MM, after using the entire $3.5MM exemption). But if the Company borrowed $3MM, lent the $3MM to an ESOP, and the ESOP purchased 30% of the stock from the owner (a transaction in which the owner may be able to elect not to recognize any gain on the sale), the Company value would be temporarily reduced to $7MM. The value of the remaining 70% held by the owner would be reduced to approximately $4.9MM. The estate/gift tax on transferring this stock would now be approximately $630,000 (45% of $1.4MM, after using the entire $3.5MM exemption); a tax savings of $2,295,000 of more than 78%.
Because the buyer is an ESOP, the owner has the flexibility to design the transaction, to transfer more or less of the stock to the ESOP and/or his heirs. This transaaction can also be combined with other estate planning tools such as family limited partnerships, to further reduce tax costs.
Of course, the owner must be interested in having a Company that is partially owned by an ESOP, including all of the tax savings and other attributes of this situation. This is not for everyone, but in the right situation it provides enormous benefit.
As ESOP advisors to business owners, Companies, and ESOP trustees, we have the privilege of seeing many such transactions succesfully help families manage business succession planning and estate tax planning at the same time.
Posted by: Steven B. Greenapple | August 17, 2009 at 07:20 AM