The federal estate and gift taxes are the most outrageous excesses of the tax code, which is in urgent need of comprehensive reforms. A hard working small business owner toils for an entire lifetime, pays income tax, state taxes and other federal deductions on all earnings and builds up a business with appreciated value. Only to find that when the time comes to transfer the business to children or heirs, the IRS wants to slash the value of the business and collect it’s share of the transaction, in the form of the estate tax for the deceased and the gift tax for living transfers.
The gift tax exemption is frozen to estate values below $1 million. The estate tax is effectively fixed at 45% for values above $2 million. This exemption limit is slated to increase to $3.5 million in 2009 and totally repealed in 2010. After which the amendment expires in 2011 at which time a transfer of estate valued above $1 million would be liable to pay the federal estate tax.
To summarize, current exemption limit is $2 million, increases to $3.5 million in 2009, gets totally abolished in 2010 and is enforced again for 2011 for amounts above $1 million. Further confusing the issue is whether or not Congress intends to make any further changes, which is highly likely. At this stage, it is difficult to predict what the estate tax will be, starting 2009 under the new Congress after the scheduled elections. However it may be, outlined below are certain strategies for reducing the estate tax burden placed on transfers of family owned businesses from one generation to the next.
If you set up the right business structure, such as a family limited partnership or family limited liability company, that gives the owner significantly more control over disposal of assets and estate planning. Secondly, you can make use of valuation adjustments. These arise out of the difference an investor might be willing to pay for a part of the business, as opposed to the value of that part of the business when compared as a whole. For example, if you have a business worth a million dollars, and you plan to sell a part, say 25% to an investor, the investor might not be willing to pay $250,000 for this. If he pays less than this amount, the difference between the percentile value and the actual amount paid is the valuation adjustment, which can be used as an estate tax reduction.
Try to hold and build up liquid assets such as insurance policies and other investment vehicles with valid tax deductions within the family limited company, though the IRS tends to scrutinize such business held investments very closely. In any case, you are advised to consult with your financial planner or CPA before you start implementing estate planning for your family business. The issue is not to avoid tax, or find loopholes in the U.S. Internal Revenue code, but plan and build your business in such a way that you fit into the bracket with the smallest tax liability, and are able to invest, or divest, the proceeds in such a way that the maximum benefits go to your heirs, instead of the taxman.