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Death & Taxes
It's never too soon to start: Estate-planning for business owners
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Business New Haven
9/18/2000
By: Fiona Phelan
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Benjamin Franklin said it best in 1789 when he quipped: “Everything appears to promise that it will last; but in this world nothing is certain but death and taxes.”
But even after death there are taxes. However, with the aid of a qualified estate-planner or tax attorney, individuals and business owners are finding ways to mitigate the impact of inheritance taxes.
While Connecticut is in the process of phasing out its estate tax, the hefty federal tax remains solidly in place. This past summer, congressional Republicans floated a proposal to end the federal estate, or “death,” tax. Despite a 279-136 vote in the House of Representatives, President Clinton vetoed the bill in June. A second vote this past month to override the President's veto failed to gain the two-thirds majority needed (274-157), and the federal estate tax will remain in place.
The argument against the estate/inheritance tax is that families and business-owners are taxed twice on the same money: They are taxed when the money is earned in life and taxed again when the money is passed on after death. Federal law exempts spouses from the inheritance tax, but not children or other heirs.
The reasoning in favor of maintaining the estate tax is that it prohibits the very rich from perpetuating their fortunes from generation to generation (one of the reasons it was established, the other being to generate revenue).
Just what is your taxable estate? According to the IRS, your taxable estate is your gross estate less allowable deductions. Allowable deductions used in determining your taxable estate include: funeral expenses paid out of your estate, debts owed at the time of death, and a marital deduction (generally, the value of the property that passes from your estate to the surviving spouse).
You must file an estate tax return with the IRS if your estate exceeds $675,000 (2000-01). For deaths in 2002 and 2003, estates over $700,000 must file an estate tax return; over $850,000 in 2004; over $950,000 in 2005: and over $1 million after 2005.
The federal estate tax is progressive, so as the value of your estate increases, so does the tax. For example, the marginal estate-tax rate on a transfer of $10,000 is 18 percent, while the rate of a transfer in excess of $3 million is 55 percent.
However, Bloomfield attorney Kevin D. Quinn notes that Congress may have to raise the current exemptions in the future if the economy continues at its current pace and more people accumulate estates in excess of $1 million.
Presently, only about two percent of the population will be impacted by the inheritance tax. If that number increases to five or ten percent, Quinn believes that Congress will act to increase the exemption amounts.
“People are becoming more financially astute,” Quinn says. “They are aware that they may not meet the minimum exemption now, but down the road they may have a taxable estate.”
In addition to personal estate-planning, those owning business have to plan for the future too. The Connecticut Business & Industry Association (CBIA) sees the estate tax as detrimental to the health and well-being of small-business owners.
“The current estate tax is extremely oppressive to some heirs of family businesses,” says CBIA Assistant Counsel Santa Mendoza. “Very often heirs are forced to sell a family business because they do not have the money available to pay the estate tax. There are no exceptions for an estate that doesn't have any cash; the tax has to be paid. Very often the only way to do this is to sell the business - and that's not what the deceased wanted to do when the business was willed to the heirs.”
According to Paul Sessions, director of the Center for Family Business at the University of New Haven, only about three out of ten family-owned businesses continue into the second generation of family ownership. Only one out of ten make it to the third generation, he adds.
Between 80 and 90 percent of U.S. businesses are family-owned or family-controlled, Sessions notes. Consequently, the estate tax affects a large number of businesses.
“A lot of it has to do with family dynamics,” explains Sessions, “but sometimes the business doesn't make it because of estate taxes. A very strong impediment to the success of a family-owned business is a lack of planning - planning for the everyday operation of the business and for the future and beyond.”
Established six years ago, the Center for Family Business helps family-owned businesses address issues such as conflicts among family members, succession issues, contrasting family and business roles. Accounting, legal, insurance and banking firms, which sponsor the center, can be tapped by members for expertise. The center (which can be reached at 203-934-7421) provides education, networking, referrals and publications to its members.
“Business owners have to address ways to legally avoid the impact of the estate tax,” notes Mendoza.
Some common practices include gifting before death, establishing life insurance trusts, qualified personal residence trusts, charitable remainder trusts, charitable lead trusts, family limited partnerships, tax credit shelters and marital trusts, to name a few.
“It's a must to have a plan,” says Mendoza. “Upon death all assets are included in your estate: your home, your car, life-insurance policies, 401(k) and other retirement funds. You have to plan before your death what is going to happen to your possessions after death.”
Connecticut began phasing out its succession tax in 1997. Anyone dying on or before January 1, 2001 may pass their estate to a spouse or children without incurring the estate tax. The tax will remain in place for siblings, aunts, uncles or other heirs until 2005, when the state tax will be completely eliminated, says Mendoza. The current tax rate in Connecticut is between ten and 20 percent, depending on the size of the estate.
Additionally, notes Quinn, there is an estate-tax exemption for small businesses, but it is not a tool he often recommends to clients. To qualify for the exemption - which excludes the first $1.3 million of the owner's estate - the business must represent more than 50 percent of the estate's value, the business must have been a going concern for at least ten years, and the heirs must keep the business going for ten years after the death, Quinn explains.
“The estate-tax burden for a small business is significant and real,” Quinn states. “One of the problems is that when determining the value of an estate, a business is valued as of the date of the death of the owner. Well, what happens if the value of the business is solely reflective of one individual's input or creativity?”
According to Quinn, one of the most important considerations in estate planning is determining how an individual wants his or her business or money to be used after he or she is gone. Is the family ready to receive a sizeable gift? If the estate is being left to married children, does the owner want the in-laws to benefit, or the grandchildren? Are they old enough and capable of handling the assets they will receive, Quinn asks.
“What's really more important than the tax planning is the counseling that goes with it,” he notes.
The best advice, no matter the size of your estate: Get help from a professional. It may cost you right now, but can save your heirs a lot of grief and expense.
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