Gifts of closely held business stock may sacrifice future savings.Successful estate tax planning Tax planning Devising strategies throughout the year in order to minimize tax liability, for example, by choosing a tax filing status that is most beneficial to the taxpayer. involves many alternatives. Adoption of an overall estate tax plan takes many of these alternatives into account. The use of one or more planning techniques depends on a taxpayer's personal, philosophical and financial goals. When an owner of a closely held A phrase used to describe the ownership, management, and operation of a corporation by a small group of people. In a closely held corporation, the same people often act as shareholders, directors, and officers, and no outside investors exist. business dies, Sec. 6166 allows the estate to defer de·fer 1 v. de·ferred, de·fer·ring, de·fers v.tr. 1. To put off; postpone. 2. To postpone the induction of (one eligible for the military draft). v.intr. payment of the portion of the estate tax attributable to the business interest over 15 years. Interest will accrue To increase; to augment; to come to by way of increase; to be added as an increase, profit, or damage. Acquired; falling due; made or executed; matured; occurred; received; vested; was created; was incurred. on the unpaid portion of the tax, but under Sec. 6601 (j), the rate is only 4% on the first $1 million in value of the closely held business interest included in the gross estate. Additional relief proposed: President Clinton's recent budget (proposed to Congress on Feb. 6, 1997) includes a provision that would increase the value of business interests eligible for the reduced rate of interest to $2.5 million. It would also reduce the interest rate to 2%, although the interest payments would no longer be deductible That which may be taken away or subtracted. In taxation, an item that may be subtracted from gross income or adjusted gross income in determining taxable income (e.g., interest expenses, charitable contributions, certain taxes). by the estate. Caution: To qualify under current law (and under the President's proposal), the business interest must exceed 35% of the decedent's adjusted gross estate (net of funeral and administration expenses, claims and outstanding debts). If, as a result of lifetime gifts, the value of the closely held business does not meet this threshold, the executor executor n. the person appointed to administer the estate of a person who has died leaving a will which nominates that person. Unless there is a valid objection, the judge will appoint the person named in the will to be executor. cannot take advantage of this provision. Example: B has assets valued at $7,000,000, which include his 25% interest in B Inc. (worth $2,500,000). If B died without making any gifts, B's estate would be entitled en·ti·tle tr.v. en·ti·tled, en·ti·tling, en·ti·tles 1. To give a name or title to. 2. To furnish with a right or claim to something: to make the Sec. 6166 election (see below). If, on the other hand, B gives $300,000 of B Inc. stock to his children before his death, the retained value of B Inc. in his estate would no longer exceed 35% of his total estate.
No gift After $300.000 gift
Value of business $2,500,000 35.7% $2,500,000 37.3%
Other assets 4,500,000 64.3% 4,200,000 62.7%
Total estate value $7,000,000 100.0% $6,700,000 100.0%
Result: By making gifts of the closely held stock, B has forfeited for·feit n. 1. Something surrendered or subject to surrender as punishment for a crime, an offense, an error, or a breach of contract. 2. Games a. the opportunity for his estate to make the Sec. 6166 election. Even if the value of B Inc. exceeded the 35% threshold after these gifts, the portion of B's estate entitled to the preferential pref·er·en·tial adj. 1. Of, relating to, or giving advantage or preference: preferential treatment. 2. interest rate on the deferred tax will be reduced below the upper limit of $2.5 million under the President's proposal. Suggestion: To take full advantage of the proposal, B should not have diminished his business holdings below 35% and not below $2.5 million. Instead, he could have given his nonbusiness non·busi·ness adj. 1. Unrelated to business or industry. 2. Unrelated to one's own business or employment. property to his children, thereby preserving the opportunity for tax deferral tax deferral The delay of a tax liability until a future date. For example, an IRA may result in a tax deferral on the amount contributed to the IRA and on any income earned on funds in the IRA until withdrawals are made. .
No gift After $300,000 gift
Value of business $2,500,000 35.7% $2,200,000 32.8%
Other assets 4,500,000 64.3% 4,500,000 67.2%
Total estate value $7,000,000 100.0% $6,700,000 100.0%
Result: By altering the subject of Bs gifts. B's estate has maximized the portion of the estate tax that can be deterred at preferential interest rates. Looks can be deceiving: The President's proposed increase to $2.5 million is not simply a 150% increase. The mechanics of Sec. 6601(j) operate in a manner that further increases the benefit. Under current Sec. 6601 (j), the portion of the deferred tax subject to the 4% rate is the lesser of (1) $345,800 less the amount of the unified credit unified credit A credit used against federal taxes due on estates and large gifts. Under current law, the unified credit is sufficient to offset taxes on values of approximately $1 million in estates and large gifts. allowable under Sec. 2010 or (2) the amount of the estate tax attributable to the closely held business. Note: $345,800 is the tentative tax on $1 million at the lowest estate tax rates. But the tentative tax on $2.5 million is $1,025,800. If the limit is increased as under the President's proposal, the estate will be entitled to defer an additional $680,000 ($1,025,800 - $345,800) of tax subject to preferential interest rates. The reduction from 4% to 2% may be largely illusory il·lu·so·ry adj. Produced by, based on, or having the nature of an illusion; deceptive: "Secret activities offer presidents the alluring but often illusory promise that they can achieve foreign policy goals without the , because the tax will no longer be deductible (see the calculation). Example continued: IF B's taxable estate Taxable Estate The total value of a deceased person's assets that are subject to taxation - minus liabilities and minus the prescribed tax-deductible portion of assets left behind by the deceased. is $6,700,000, the estate tax will be $3,133,000. The following chart shows the portion of the state tax entitled to preferential interest and the interest incurred both the present and the proposed laws.
Current Budget Increase/
law proposal (decrease)
Estate tax available
preferential rates $153,000 $833,000 $680,000
Yearly interest on deferral:
Current law
$153,000 @ 4% - deductible
(@ 55% tax = 1.8% net) 2,754 N/A
$680,000 @ 9% - deductible
(@ 55% tax = 4.05% net) 27,540 N/A
Budget Proposal
$153,000 @ 2% (nondeductible) N/A 3,060
$680,000 @ 2% (nondeductible) N/A 13,600
Total 30,294 16,660 (13,634)
Interest accumulated over 5 years:
Current law
$153,000 @ 4% - deductible
(@ 55% tax = 1.8% net) 14,275 N/A
$680,000 @ 9% - deductible
(@ 55% tax = 4.05% net) 149,315 N/A
Budget proposal
$153,000 @ 2% (nondeductible) N/A 15,924
$680,000 @ 2% (nondeductible) N/A 70,775
Total $163,590 $86,699 $76,891
Result: By preserving the ability to take advantage of the Sec. 6601 (j) proposals, B can enhance the value of an already potent estate reduction tool. |
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