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Estate Planning Inspires Change in Federal Tax Rules.

THE ESTATE TAX, WHICH opponents say can devastate a family business or farm, will be re pealed in 2011.

The Tax Reconciliation bill passed the U.S. Senate Wednesday, 62-38, and part of the bill calls for the phase-out of the estate tax.

House and Senate leaders are working out a final compromise of the bill before it is sent to President Bush's desk. Bush has said he supports the $1.35 trillion tax-relief package.

Sen. Tim Hutchinson, R-Ark., supported the elimination of the tax be cause it costs small businesses too much to plan for the estate tax, said D.J. O'Brien, a spokesman for Hutchinson.

O'Brien said that a study shows that a small business had to spend about $125,000 over a five-year period to avoid paying the tax.

"And these costs are incurred prior to any actual payment of the federal estate tax," O'Brien said. "If you can escape the death-tax hatchet, you still have to pay enormous costs to lawyers and consultants to get around that."

The estate tax hits small businesses and family farmers particularly hard, said Bud Cummins, state director for the National Federation of Independent Business, which supported eliminating the tax.

"Family members are required to pay a lump-sum payment in cash on the estimated value of all cash and non-cash assets," Cummins said. "Families often have to sell off a lot of their land or equipment, maybe all of it, to pay the death tax bills."

Others, however, disagreed.

Rep. Vic Snyder, D-Ark., said of the 2 percent of the estates that pay the tax, only 4 percent of those are made up of family-owned businesses or farms. And it is difficult to find any examples of businesses that went under because the second generation had to pay the estate tax, he said.

The repeal of the tax saves billions of dollars only for a few individuals, Snyder said.

Snyder said he would have preferred an exclusion to the tax raised to $2 million-$2.5 million per individual, which would mean about $5 million for family owned businesses and farms. Previously, up to $1.3 million of a family-owned business could pass free of the estate tax.

John Lyle III, an estate planning attorney in Birmingham, Ala., said he almost never sees a business sold to pay the estate tax.

"It is still a significant burden for families to have to deal with," Lyle said. "We have certainly seen people sell the businesses over their lifetime to avoid that from happening."

But having to pay the estate tax should be no reason for the business to fold, said Mike Munnerlyn, a Little Rock attorney who concentrates on estate and business planning.

With proper planning, a business owner could overcome the estate tax hurdle, he said.

"We always recommend buying some life insurance to give the business liquidity," Munnerlyn said. "They need the liquidity at death to pay the estate tax."

With life insurance, the business owner would effectively pass on to the next generation the same dollar value of the estate, "but still the government is going to get a fairly significant chunk of money from the estate tax," Lyle said.

There is some relief for family businesses, said Jack Grundfest, a tax and estate planning attorney with Mitchell Williams Selig Gates & Woodyard in Little Rock.

One provision in the Internal Revenue Code is called the qualified family-owned business deduction. But the estate has to pass a liquidity test, which means that the business has to be worthmore than 50 percent of the estate.

Another provision allows for an extended payout of the estate tax.

If the family business exceeds 35 percent of the value of the estate, the person paying the tax is eligible to pay only the interest for the first five years and the remainder of the estate tax and interest over the next 10 years in equal annual installments.

Both of those provisions have technical requirements, however, Grundfest said.

The Next Generation

One study estimates that 70 percent of all family businesses don't survive to the next generation and 85 percent don't make it to the third, O'Brien said.

When the business fails in the second generation, a lot of times it's because the children don't share the same interest or don't have the same management ability as the parents, Munnerlyn said.

And entrepreneurship is not genetic, Lyle said.

The parent who says he doesn't want his child to have to struggle fails to recognize that it was the struggle that made him competitive and successful.

"When you do that, frequently, the family business only succeeds when you have a child who marries someone who brings in new ideas and hungriness to make the business succeed," Lyle said. "That's a real problem -- making sure that the next generation is as motivated as the previous one to make things happen."

But sometimes the next generation will take a company to the next level and make it a national company.

The family business could get very complicated very quickly when it comes to deciding which child is the best one to control the business.

"Any discussion over money can become heated and emotional, [and] when you add that family dynamic to it, that adds a whole different context of discussion," Lyle said.

"Sometimes it's not so much what's best for the company but what somebody said at the Thanksgiving dinner table in 1983," he said.

Another potential problem the owner of a family business faces is when he has multiple children but only one wants to continue the shop. It creates a delicate situation because typically the parent wants to benefit each child equally, Lyle said.

In that situation, the child involved in the business should buy the parent out before he dies, he said.

"A lot of times it's impossible to have an equitable distribution because the value of the business is 80 percent of the estate," Munnerlyn said. "So the child getting the business could pay his or her sibling off over time. That's where some life insurance comes in to even it out."
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Comment:Estate Planning Inspires Change in Federal Tax Rules.
Publication:Arkansas Business
Article Type:Brief Article
Geographic Code:1USA
Date:May 28, 2001
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