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- Estate Planning Basics
- Fundamental questions
- Will or living trust?
- Other facts about estate settlement
- Determining potential estate taxes
- Estate Tax Saving Strategies
- The marital deduction
- Life Insurance
- Annual gifting
- Charitable contributions
- Strategies for family-owned businesses
- Special strategies for special situations
- Community property issues
- Implementing and Updating Your Plan
- Where do you go from here?
- Estate planning worksheet
- Planning Levels Fee Schedule
STRATEGIES FOR FAMILY-OWNED BUSINESSES
Few people have more estate planning issues to deal with than the family-business owner. The business may be the most valuable asset in the owner’s estate. Yet, two out of three family-owned businesses don’t survive the first generation. If you are a business owner, you should address the following concerns as you plan your estate:
Who will take over the business when you die? Owners often fail to develop a management succession plan. It is vital to the survival of the business that successor management, in the family or otherwise, be ready to take over the reins.
Who should inherit your business?
Splitting this asset equally among your children may not be a good idea. For those active in the business, inheriting the stock may be critical to their future motivation. To those not involved in the business, the stock may not seem as valuable. Perhaps your entire family feels entitled to equal shares in the business. Resolve this issue now to avoid discord and possible disaster later.
- Planning tip 6
- Leave A Legacy With A Private Foundation or Donor-Advised Fund
You can form a private foundation to support your charitable activities or to make charitable grants according to your wishes. If the foundation qualifies for tax-exempt status, your charitable contributions to it will be deductible, subject to certain limitations.
An alternative to consider is a donor-advised fund. Generally, such funds are sponsored by a large public charity that allows you to make contributions that are used to create a pool of funds you control. Thus, a donor-advised fund is essentially a small-scale private foundation that requires much less administration.
Whether a private foundation or a donor-advised fund is right for you depends on various factors. Although there may be less incentive to create such vehicles in light of the increasing estate tax exemption (and potential repeal), they are still viable options worth exploring.
How will the IRS value your company?
Because family-owned businesses are not publicly traded, knowing the exact value of the business is difficult without a professional valuation. The value placed on the business for estate tax purposes is often determined only after a long battle with the IRS. Plan ahead and ensure your estate has enough liquidity to pay estate taxes and support your heirs.
Take advantage of special estate tax breaks
Current tax law has provided two types of tax relief specifically for business owners.
Section 303 redemptions.
Your company can buy back stock from your estate without the risk of the distribution being treated as a dividend for income tax purposes. Such a distribution must, in general, not exceed the estate taxes and funeral and administration expenses of the estate. One caveat: The value of your familyowned business must exceed 35% of the value of your adjusted gross estate. If the redemption qualifies under Section 303, this is an excellent way to pay estate taxes.
Estate tax deferral. Normally, your estate taxes are due within nine months of your death. But if closely held business interests exceed 35% of your adjusted gross estate, the estate may qualify for a deferral of tax payments. No payment other than interest is due until five years after the normal due date for taxes owed on the value of the business. The tax related to the closely held business interest then can be paid over as many as 10 equal annual installments. Thus, a portion of your tax can be deferred for as long as 14 years from the original due date. Interest will be charged on the deferred payments. (See Case study V.)
- Case Study V
- Sometimes Putting Off Until Tomorrow Makes Sense
Lee owned a small manufacturing company that accounted for 50% of his estate. When he died in October 2004, his estate’s total estate tax liability was $1 million. Half of the liability was due at the normal due date of his estate’s tax return in July 2005 (nine months after Lee’s death). The other $500,000 of liability could be paid in 10 installments, starting in July 2010 (five years and nine months after Lee’s death) and ending in July 2019. Lee’s estate would also have to pay interest on the unpaid liability each year, but at special low rates.
Ensure a smooth transition with a buy-sell agreement
A powerful tool to help you control your — and your business’s — destiny is the buy-sell agreement. This is a contractual agreement between shareholders and their corporation or between a shareholder and the other shareholders of the corporation. (Partners and limited liability company members also can enter into buy-sell agreements.)
The agreement controls what happens to the company stock after a triggering event, such as the death of a shareholder. For example, the agreement might provide that, at the death of a shareholder, the stock is bought back by the corporation or that the other shareholders buy the decedent’s stock.
A well-drafted buy-sell agreement can solve several estate planning problems for the owner of a closely held business and can help ensure the survival of the business. (See Planning tip 7.)
Remove future appreciation by giving stock
The key to reducing estate taxes is to limit the amount of appreciation in your estate. We talked earlier about giving away assets today so that the future appreciation on those assets will be outside of your taxable estate. There may be no better gift than your company stock — this could be the most rapidly appreciating asset you own.
For example, assume your business is worth $500,000 today, but is likely to be worth $1 million in three years. By giving away the stock today, you will keep the future appreciation of $500,000 out of your taxable estate.
- Planning tip 7
- Protect Your Interests With A Buy-Sell Agreement
A buy-sell agreement offers three key benefits:
- It provides a ready market for the shares in the event the owner’s estate wants to sell the stock after the owner’s death.
- It sets a price for the shares. In the right circumstances, it also fixes the value for estate tax purposes.
- It provides for stable business continuity by avoiding unnecessary disagreements caused by unwanted new shareholders.
Gifting family business stock can be a very effective estate tax saving strategy. But beware of some of the problems involved. The gift’s value determines both the gift and estate tax ramifications. The IRS may challenge the value you place on the gift and try to increase it substantially. Seek professional assistance before attempting to transfer portions of your business to family members.
Finally, the IRS is required to make any challenges to a gift tax return within the normal three-year statute of limitations, even though no tax is payable with the return, but only if certain disclosures are made.