Estate Planning For Family Owned Businesses Family business can be considered a vital force in the United States economy. According to the recent statistic data, approximately ninety percent of all American businesses are family controlled or family owned. According to the estimates, family owned and controlled businesses generate approximately 50% of the United States GDP and about 50% of the total waged paid. Family owned businesses may range in size from micro businesses to large companies, however, all of them have similar problems when they face the need of estate planning. At any given period of time approximately 40 percent of the United States family owned businesses need to manage ownership issues. At a certain period of time business owner needs to decide what to do with the business, however, there are relatively few options. Business owner can decide to close the business, to sell it to another person, whether he is an employee or an outsider, to retain business ownership but hire the management from outside, to retain management control and family ownership, to mention a few.
However, in order to transfer business ownership successfully, it is crucial to implement successful estate planning solutions to ensure successful transfer of family owned business within the family hierarchy. Estate planning is important both for business and for the family, because with no estate plan, the business owner will pay significantly higher taxes than it is needed. Therefore, developing estate plan will serve as an additional guaranty that your estate will not go primarily to taxes, but to your heirs. In the vast majority of family owned businesses, the assets are tied up in the business. The following information will assist you in estate planning. The income law that was passed in 1990, has brought estate freeze, a so-called recapitalization technique (Breton-Miller, Miller and Steier).
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Estate freeze allows business owners to reduce estate taxes offering them to freeze the value of their businesses at a certain point in time. Estate taxes can be reduces as the vast majority of the stock in family owned businesses doesn’t appreciate over time. Business owners can create preferred stock thus being able to retain operating control and make successful transfer of common stock to the heirs (children).
This solution can be quite effective, because common stock can appreciate over time, while preferred stock will not. Yet, it should be also taken into consideration that when the preferred stock will be transferred to the business owner’s children, the children will have to pay estate taxes (namely, gift taxes) (Armstrong).
However, as far as tax laws undergo constant changes and amendments, it is recommended to obtain consultations with the legal counsel.
Let’s examine transfer tax deferral techniques, such as living trust, the will, installment payment and marital deduction trust (Burnett and Pulliam).
So, testament and the will can be used by the business owner as a legal expression of the owners desires concerning the disposition of the probate estate. The testament is a common element of estate plans. In its turn, the living trust is an agreement that can be changed at any certain period of time. This agreement is concluded between the donor (the creator, or a business owner) and trustee (property manager) for the benefit of a beneficiary (the recipient of the living trust).
This kind of completely changeable agreement is created when the business owned is alive, and holds assets for the use of the donor (a business owner) until his death. Upon the business owners death the living trust is used for transferring property outside his will, as one part of his non-probate estate. Also, the living trust can be recommended to use when there is a need to manage the business owner’s property during his or her disability that lasts for a relatively long period of time. There is also another transfer tax deferral technique, namely, the marital deduction trust.
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The business owner can create this trust in the testament of the will or in the living trust for the benefit of his or her spouse after the donor’s death. Under general conditions of the marital deduction trust, the spouse will receive a mandatory distribution of income from the trust property as a minimum benefit (Sharma and Manikutty).
Also, the business owner can limit the rights of his or her spouse to the trust principal in this trust agreement while the owner is alive. What concerns taxes, it should be mentioned that according to the legislation currently in force, the property, which is placed in a qualified marital deduction trust will not be subject to federal estate tax when the business owner dies. It will be subject to tax only after the spouse’s death. This kind of trust is also known as a qualified terminable interest property trust, or QTIP Trust. What concerns the disposition of the property placed in this trust, remained there by the moment of spouses death, it will not be determined by the will or testament of the spouse, but under terms and conditions of the trust agreement. Finally, there is another transfer tax deferral technique called the installment payment. According to the Internal Revenue Code Section 6166 family owned businesses are eligible for a 14-year payout of the federal estate tax (Sharma and Manikutty).
In compliance with it, family owned business should be an active business or an active trade, and the interest of the business owner in this business should be equal at least thirty five percent of the estate. In case family owned business successfully qualifies, business owner will get right to pay no estate tax on the value of business for the period of five years. However, the federal estate business (including annual interest) will be paid then in equal amounts over a 10 year period starting from the fifth year. It should be also noted that if children or any other heirs of the business owner will decide to sell at least 50 percent (or more) of the interest in the family owned business, the estate tax payments will be accelerated (Breton-Miller, Miller and Steier).
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In addition to transfer tax deferral techniques, it is important to examine the use of transfer tax exclusion techniques. These tools include the dynastic trust, the unified credit/exemption equivalent trust, unified credit/exemption equivalent gift, the annual exclusion gift and the statutory grantor retained interest trust. Business owner can create unified credit/exemption equivalent trust in his or her living trust or testament for the benefit of any person.
This trust is funded with the maximum possible amount of estate property business owner desires to leave to beneficiary (or beneficiaries) other than the owner’s spouse, and in this case no federal estate tax will be applied (approximately up to $600,000).
Also, while the business owner has right to assign any beneficiary or trustee, the common practice is to designate children or spouse as beneficiaries. The dynastic trust is another transfer tax exclusion instrument. It can be created by the business owner in a living trust or in the owner’s will. Similar to the unified credit/exemption equivalent trust, the dynastic trust is usually funded with the maximum amount of property, however, in this case it relates to the property, which will be left to grandchildren or any other third generation beneficiaries (usually up to $1,000,000) (Salter).
No federal generation-skipping transfer tax will be applied to this amount.
The annual exclusion gift also related to the set of transfer tax exclusion instruments. As the title implies, it comprises of gifts of cash (or any other property up to $10,000 per one recipient per year. Under the terms and conditions of the annual exclusion gift, these gifts of cash or any other property are not subject to federal gift taxation. Also, these gifts, including future income the beneficiary will get from them and their appreciation also subject to no generation-skipping transfer taxation and federal estate tax. Another transfer tax exclusion technique that can be used by the owner of family owner business, is the unified credit/exemption equivalent gift. This is a gift of a personal interest or a future interest in the property that exceeds the amount of annual exclusion gift.
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The unified credit/exemption equivalent gift can be done by the business owner during his or her lifetime with being subjected to no federal gift taxation. The amount of this gift may not exceed $600,000 (Benson).
Income of property from the owner’s estate for the purposes of federal transfer taxation will also be excluded. Finally, there is another transfer tax exclusion technique, namely the statutory grantor retained interest trust. This type of trust can be created by the business owner during his lifetime. Under the statutory grantor retained interest trust, an income interest in the property, which is placed in trust is retained for a 10 year period of time. Also, under the terms of this trust, a remainder of the interest in property transferred to the trust will be transferred to the third party at the end of this term.
According to the IRS table, the value of the gift is the value of the remaining interest (Barker and Sa-Aadu).
If, when the 10 year period of time is over, the business owner is still alive, the value of the trust property will be excluded from the owners estate. However, if the business owner dies during the given term, the trust property will be subject to federal estate taxation. In conclusion it should be said that it is recommended to seek competent legal advice before planning the estate, as there are many aspects business owner should take into consideration to ensure successful transfer of family owned business within the family hierarchy. Works Cited Altfest, L. “Personal Financial Planning: Origins, Developments and a Plan for Future Direction.” American Economist 48.2 (2004): 53. Armstrong, L. “A Home Is the Foundation for Wealth: Daphne and Gary Dixon Have Used Real Estate to Ensure Their Prosperity: The Dixons Are Showing Their Son and Daughter How Using Real Estate Can Help You Reach Your Financial Goals.” Black Enterprise 34.6 (2004): 54.
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