It is common for manufacturers and distributors to be family-owned. Unfortunately, it is also common for owners to let estate planning fall by the wayside. This can cause the owners and their family members to lose out on valuable tax-saving opportunities.
The American Taxpayer Relief Act of 2012 (ATRA) brought some certainty to estate planning. However, the current legislative calm could be disrupted without warning by future tax reform efforts on Capitol Hill. If you have not recently reviewed your plans for transferring wealth and management responsibilities to the next generation, now is the time to do so.
What are the Current Rates and Exemptions?
Under ATRA, the top gift and estate tax rate is now 40%. The law also permanently sets the gift and estate tax exemption of $5 million which is adjusted annual for inflation. For 2014, the adjusted exemption is $5.34 million. As a business owner, you can transfer up to that amount tax-free to your heirs while you are alive and bequeath whatever amount is remaining tax-free on your death.
The same tax rate and exemption amount apply to the generation-skipping transfer (GST) tax. Generally, this tax is assessed, in addition to the gift or estate tax, on transfers to grandchildren and others more than one generation below you.
There are ways to gift amounts to your heirs throughout your lifetime. The annual gift exclusion remains unchanged at $14,000 per donor and recipient in 2014. In other words, a married couple can gift up to $56,000 to their son and daughter-in-law (each parent can gift $14,000 to their son and daughter-in-law, individually, which results in four gifts of $14,000) tax-free without using up any of their gift and estate tax exemption. Annual exclusion gifts are also excluded from the GST tax. In addition, individuals can pay unlimited medical and tuition expenses on behalf of their family members without incurring gift tax. These payments must be made directly to the providers.
The unlimited marital deduction for wealth transfers between spouses remains unchanged. But ATRA made the “portability” of the estate tax exemption between spouses permanent, too. This means that, if one spouse dies with part (or all) of his or her exemption unused, the estate may elect to permit the surviving spouse to use the deceased spouse’s remaining exemption. Unfortunately, portability does not apply to the GST tax exemption and some states do not recognize portability.
How Much Will Be Subject to Estate Tax?
For example, let us say a retiring plastics manufacturer decides to sell his business to the management team for $15 million. He will get $5 million in upfront cash and $2 million per year for the next five years. Under the marital deduction, all of the sale’s proceeds could be transferred to a surviving spouse estate-tax-free on the business owner’s death.
Following the surviving spouse’s death, up to an inflation-adjusted $10 million, the combined gift and estate tax exemption amount for both spouses, could be transferred tax-free to the couple’s only child. The remainder of the estate could be taxed at 40%. Keep in mind that additional estate and inheritance taxes may apply at the state level.
What are My Options?
Some family business owners are not ready to hand over the reins to their heirs just yet. They want time to groom the next generation to run the show. There are various estate planning tools, such as family limited partnerships and certain trusts that help balance the transfer of wealth with the retention of managerial control.
Before you can decide which estate planning tools to use, however, you need to know how much your business is worth. Minority interests in small to midsize companies may be subject to discounts for lack of control and marketability that only a qualified business appraiser knows how to quantify and support. Market values also fluctuate as the economy ebbs and flows, so you will need regularly updated business appraisals to ensure your estate plan continues to make sense.
Can’t Estate Planning Wait Until Next Year?
Business owners who neglect estate planning risk leaving behind a significant tax bill when they die. Your business interest is probably your biggest asset. Be sure to protect it, and your loved ones, by contacting your tax advisor and attorney about estate planning today. For assistance on estate planning, contact Amy Jackson at 312.670.7444.