Small business tax solutions.What impact does the family-owned business exclusion -- signed into law by President Clinton on August 5, 1997, as part of the Taxpayer Relief Act of 1997 -- have on succession planning Management Succession Planning In organizational development, succession planning is the process of identifying and preparing suitable employees through mentoring, training and job rotation, to replace key players — such as the chief executive officer (CEO) — for family businesses? Family business start-ups began to surge following the en of World War II. Now, 50 years later, as the founders either retire or die, these businesses are being passed on to the next generation. This has created a crisis for businesses that had long been stable and has put Congress under pressure to ease the potentially devastating dev·as·tate tr.v. dev·as·tat·ed, dev·as·tat·ing, dev·as·tates 1. To lay waste; destroy. 2. To overwhelm; confound; stun: was devastated by the rude remark. impact of estate taxes on the survival of these businesses. Congress provided family businesses with partial estate tax relief in TRA TRA Training TRA Transfer TRA Transition TRA Tennessee Regulatory Authority TRA Telecommunications Regulatory Authority (Oman) TRA Tax Reform Act (1976, 1984, or 1986) TRA Teachers Retirement Association 1997 by enacting Internal Revenue Code The Internal Revenue Code is the body of law that codifies all federal tax laws, including income, estate, gift, excise, alcohol, tobacco, and employment taxes. These laws constitute title 26 of the U.S. Code (26 U.S.C.A. § 1 et seq. section 2033A -- the family-owned business exclusion. OVERVIEW OF THE PROVISIONS The new exclusion may reduce the gross estate of business owners by the lesser of (1) the adjusted value of the decedent's qualifying family-owned business interests otherwise includable in the estate of (2) the difference between $1.3 million and the applicable exclusion 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. for the estate. For example, if the founder of company X dies in 1998 when the unified credit exempts $625,000 from tax an the adjusted value of her business interest is $1 million, the exclusion amount would be $675,000 ($1,300,000 -- $625,000). If the adjusted value of her business interest is $500,000, the exclusion would be limited to $500,000. Its is important for practitioners to note that the family-owned business exclusion applies in addition to the IRC (Internet Relay Chat) Computer conferencing on the Internet. There are hundreds of IRC channels on numerous subjects that are hosted on IRC servers around the world. After joining a channel, your messages are broadcast to everyone listening to that channel. section 2032A special use valuation and section 6166 installment payment provision. Qualifying business interests. A family-owned business interest qualifies for relief if it is a trade or business interest in either a proprietorship Proprietorship An unincorporated business that is owned and operated by only one person who has complete liability for all assets, and complete rights to all profits. proprietorship or an entity of which 50% is owned by the decedent An individual who has died. The term literally means "one who is dying," but it is commonly used in the law to denote one who has died, particularly someone who has recently passed away. and members of his or her family, 70% is owned by members of two families or 90% is owned by members of three families. For an interest to qualify under the 70% or 90% tests, at least 30% of the entity must be owned by the decedent and members of his or her family. In the case of a corporation, the ownership test is based on the decedent's family owning a requisite percentage of the total combined voting power of all classes of stock 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 vote and the total value of all shares of all classes of stock. In the case of a partnership, the ownership test is based on the decedent's family owning a requisite percentage of both the capital interests an the profit interests in the partnership. Nonqualifying business interests. In addition to defining the business interests that qualify as family-owned business interests, the new code section defines business interests that specifically do not qualify, including * Any interest in a trade or business with its principal place of business outside the United States United States, officially United States of America, republic (2005 est. pop. 295,734,000), 3,539,227 sq mi (9,166,598 sq km), North America. The United States is the world's third largest country in population and the fourth largest country in area. . * Any interest in an entity if its stock or securities were publicly traded at any time within three years of the decedent's death. * Any interest in a business other than a bank or domestic building and loan association if more than 35% of its gross income in the year of the decedent's death would qualify as personal holding company income (dividends, interest, royalties and other investment-type income pursuant to IRC section 543(a)). * The portion of an interest in a business that is attributable to cash or marketable securities Marketable Securities Very liquid securities that can be converted into cash quickly at a reasonable price. Notes: Marketable securities are very liquid as they tend to have maturities less than one year, and the rate at which these securities can be bought or sold has in excess of the reasonably expected day-to-day working capital needs of the business. * The portion of an interest in a business attributable to any other assets other assets Assets of relatively small value. For financial reporting purposes, firms frequently combine small assets into a single category rather than listing each item separately. of the business that produce various types of passive income (dividends, interest, royalties and certain other types of passive income). Qualifying estates. Since the purpose of the new exclusion is to prevent a forced sale or liquidation The collection of assets belonging to a debtor to be applied to the discharge of his or her outstanding debts. A type of proceeding pursuant to federal Bankruptcy to pay estate taxes, the estate must meet two additional requirements: 1. A 50% liquidity test. The family-owned business interests transferred by the decedent must exceed 50% of the value of the estate. 2. A five-of-eight-year participation test. The decedent or a member of his or her family must have owned and materially participated in the business for at least five of the decedent's death. In addition to these two tests, an estate qualifies for the exclusion only if the decedent was a U.S. citizen or resident at the date of his or her death. 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. must elect the exclusion and must file an agreement in which each person with an interest in the business consents to the recapture recapture n. in income tax, the requirement that the taxpayer pay the amount of tax savings from past years due to accelerated depreciation or deferred capital gains upon sale of property. (See: income tax) RECAPTURE, war. rules described below. Recapture rules. The estate tax benefits of the exclusion are subject to recapture, in the form of additional estate tax, if one of the following events occurs within 10 years after the decedent's death and before the death of the qualified heir: * The family members cease their material participation in the business for five years of any eight-year period. * The qualified heir disposes of any portion of the qualified business interest other than by a disposition to a member of the qualified heir's family or through a qualified conservation contribution. * The qualified heir loses U.S. citizenship and does not comply with the security requirements that would avoid recapture. * The principal place of business ceases to be located in the United States. The amount of additional estate tax triggered by a recapture event is the applicable percentage of the adjusted tax difference attributable to the qualified family-owned business interest, plus interest on such amount at the IRC section 6621 underpayment rate. The applicable percentage of recapture tax is 100% for recapture events occurring in the first 6 years of material participation, 80% in year 7, 60% in year 8,40% in year 9 an 20% in year 10. A SMALL STEP Although certainly not a step toward simplification, section 2033A is a small step toward shielding the family farm or family business that will be continued by the next generation from the devastating impact of estate taxes. Along with certain technical amendments to section 2032A and section 6166, section 2033A is a welcome provision that should be widely used by family businesses until the increasing unified credit effectively eliminates the exclusion's usefulness and until broader relief is available. |
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