Planning for Business Owners
By Robert J. Saalfeld
SAALFELD GRIGGS PC
Few people have more estate planning issues to deal with than family business owners. The business may be the most valuable asset in your estate, yet two out of three family-owned businesses do not survive the first generation. Following are four key questions business owners should address as they plan their estates:
1. WHO WILL TAKE OVER MANAGEMENT OF THE BUSINESS WHEN YOU DIE?
Many business owners fail to develop a management succession plan. It is critical to the survival of a business that successor management, in the family or otherwise, be available to take over the reins. If management is to stay in the family, deciding whether control will be with one family member or shared is also important.
2. WHO SHOULD INHERIT THE BUSINESS?
The business is usually not the best asset to split equally among the family. Children active in the business will have different motivations and concerns than children not active in the business. The interest of a surviving spouse may also differ from that of children. For instance, children active in the business often want capital to stay in the business for future business needs, while inactive children, or their spouses, naturally want distributions from the business. Arguments can also arise over salaries paid to children active in the business. If the children who are active in the business are to inherit the business, the other children can receive non-business assets and life insurance to increase their share of the estate. However, in many cases trying to make all the children’s shares mathematically equal is simply not feasible.
The question of who will inherit ownership needs to be resolved to avoid conflict and possible disaster later. Once you have made your decision, a family meeting to let all the children know of your plan is helpful in resolving tensions after your death.
3. HOW WILL THE IRS VALUE YOUR COMPANY?
Your personal representative or trustee will hire a business appraiser to value the business after your death. If the IRS disagrees with the value, the IRS hires its own appraiser. If the business is incorporated, many owners are reducing their eventual estate tax liability through valuation discounts on their stock. One method is gifting during your life non-voting stock to the children who will inherit the business. With non-voting stock, you can maintain control, but the value of the reported gift is discounted, sometimes significantly, because it is a non-controlling interest. You can give $10,000 per year per child, or use some of your exclusion ($675,000 for 2000 and growing to $1,000,000 in 2006). For $10,000 annual exclusion gifts, the entire gift and any discount is removed from your taxable estate. For larger gifts, the valuation discount on the gift and the appreciation on the gift until your death is removed from your taxable estate. To substantiate the value of the gift, however, a business appraisal should be obtained.
A second method to reduce the value for tax purposes of your stock is for each parent to own a minority interest at death. For instance, each parent could own 49% of the stock, and the child could own 2%. If the first parent to die’s stock is transferred to a special “By-Pass” or “QTIP” trust for the surviving spouse, both 49% percent interests will be discounted in value for death tax purposes.
4. HOW WILL DEATH TAXES BE PAID AND WHO WILL PAY THEM?
Even with valuation discounts and proper planning so both spouses rather than only one have an exclusion, there still may be a death tax. The death tax is due within 9 months of death. Does your estate have enough liquidity or assets that can be readily sold to pay the death tax? In many cases, having second-to-die life insurance owned by a irrevocable life insurance trust (“ILIT”) is a useful strategy to provide such liquidity. Insurance proceeds in the insurance trust pass death tax free to the beneficiaries who can use the money to pay the death tax.
Another question that needs to be resolved is which estate distribution should bear the death tax: the business assets, the rest of the estate, or should the tax be apportioned among all beneficiaries according to the value each received?
One person said a successful business owner has to do two things well:
- Set the mission for the company.
- Plan for the succession of the business.
Many business owners do the first one well, but fail to focus on the second objective. By planning ahead, you can allow the ownership and management of your business to transfer to the appropriate individuals, with reduced death tax, and with a better chance for the business to survive in the future.