Estate Planning for Business Owners

By Maccarrone, Eugene T.; Warshavsky, Mark S. | The CPA Journal, September 2003 | Go to article overview

Estate Planning for Business Owners

Maccarrone, Eugene T., Warshavsky, Mark S., The CPA Journal

Foresighted valuations help maintain wealth

The complexity of estate planning increases markedly when the subject of the plan is a business owner. The taxpayer's business interests can complicate the usual planning considerations in designing a strategy that minimizes estate and gift taxes and maximizes family wealth. This is particularly true when the business relies on the taxpayer's active participation to maintain its value.

The Family Business and Maintenance of Family Wealth

Considerations regarding the inclusion of business interests in an estate plan may be analyzed in two phases. First are the lifetime concerns of business owners as to how they can best manage the business to maximize its wealth for the benefit of their family. In this phase, present factors affecting the taxpayer's wealth, including business value, are considered. The following estate planning factors can influence the valuation of business interests:

* Lifetime gifting and gift tax computation

* The transfer tax basis (for computation of gain or loss on subsequent disposition)

* The sale of a business interest to outsiders or to a shareholder pursuant to a shareholders' agreement during the owner's lifetime

* Business stability and continuity

* Generation-skipping taxes.

The second phase addresses estate concerns regarding the ultimate definition of a taxpayer's wealth, including business interests. These factors include those noted above, as well as additional considerations that arise because of death:

* Estate taxes

* Business interest valuation without regard to special considerations)

* Special use valuation and other special valuation considerations

* Alternate valuation date

* The family-owned business deduction

* Estate liquidity.

Many of these factors are affected by recent changes to federal estate and gift tax rules. The Economic Growth and Tax Relief Reconciliation Act of 2001 will have far-reaching effects on family wealth planning, with a number of provisions specifically focused on business owners. For example, the 2001 Tax Act repeals the family-owned business deduction in 2004 (deduction of the value of a family-owned business up to $1.3 million, less the federal exemption equivalent amount from the value of a decedent's estate) and limits, beginning in 2010, the traditional step-up in tax basis of a decedent's property to the fair market value at death (or at the six-month alternate valuation date). A decedent's estate will then be permitted to increase the basis of assets transferred only up to a total of $1.3 million, with an additional step-up of $3 million for assets going to a surviving spouse (total to a spouse of $4.3 million). Furthermore, special use valuation reduction for qualified farms and closely held businesses is set to increase to a maximum reduction of $820,000 (indexed for inflation).

Even where the 2001 Act is silent, continuation of past law will affect wealth planning. For example, the six-month alternate valuation date is retained, as are the penalties for tax underpayments attributable to "substantial" and "gross" valuation understatements (20% and 40% of the portions of the understatements, respectively, where the underpayment exceeds $5,000).

The Role of the Business Valuator

The business valuator assists the other estate professionals by performing the analytical work necessary to obtain an appropriate and supportable business valuation for family wealth planning and estate planning purposes. The IRS has escalated its challenges to the valuation of closely held businesses in the estate taxation arena. Without proper analysis and documentation, taxpayers have little chance of successfully disputing an IRS challenge. A taxpayer's chances are much better where a qualified valuator furnishes a well-prepared report.

There are many possible instances where a business valuator is indispensable in the event of an IRS challenge of the gift or estate valuations, or, for that matter, on the gain or loss computation on the subsequent disposition of the property in question. …

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