October 29, 1998

Laura May

The George Washington University

As many know, the two constants in every life are death and taxes. The issue of Estate (Death) Taxes is ranked number 61 on the list of Small Business Problem areas. Not only is it relevant to every individual in estate planning but also for small business owners, particularly family-owned businesses. Recent developments in tax legislation have provided an immediate additional benefit for family owned businesses beginning in 1997.

The recent legislation has increased the tax exempt level of assets (excluding bequests to surviving spouses and charities) from $600,000 in 1997 to $1,000,000 in 2006. The increase in the federal unified credit is gradual from 1997 to 2006 as shown in Table 1. Additionally, the new legislation allows family-owned businesses to qualify for an immediate $1,300,000 exemption from federal estate taxation. The actual amount of this exemption will gradually decrease to $300,000 in 2006 as the individual exemption increases to $1,000,000.

  To qualify for the Additional Family-Owned Business Exemption, the following criteria must be met:

• The decedent must have been a U.S. resident; and
• The business must make up more than 50% of the decedent’s estate; and
• The decedent or another family member owned and worked in the business for at least five of the eight years preceding the decedent’s death; and
• The decedent’s family owns at least 30%of the business; and
• The decedent’s heirs will work for at least 10 years after the decedent’s death. [If the heirs leave the business prior to the seventh year, the IRS will be to recapture the entire exemption plus interest; if depart within the seventh year 80%; in the eighth year 60%; in the ninth year 40%; in the tenth year 20%.

Effective estate planning involves reducing the size of your estate in order to reduce estate taxes that, which could consume up to 55% of your estate, through the use of:

• Wills – Identifies such things as who will take care of your children and bequests.
• Trusts – Allows an individual to transfer assets to a third party for the benefit of another.
• Irrevocable Trust – The grantor gives up control of the property transferred to the trust. These assets are not considered part of the grantor’s estate.
• Revocable Trust – The grantor may retain the right to control and receive income from the trust. Theses assets are considered to be part of the estate and subject to estate taxes because of the control retained.
• Insurance – A common problem with many estates is the lack of liquid assets. Many families have most of their net worth derived from real estate and business ownership. Life insurance is a great vehicle to provide liquidity needed to cover estate taxes. Life insurance proceeds are income tax free and may be estate tax free if placed in an irrevocable life insurance trust.
• Term Insurance – The least expensive type of insurance in the early years, but increases over time.
• Whole Life Insurance – Purchased for your entire life at a predetermined premium with a cash value that can be borrowed upon if necessary.
• Variable Life Insurance – Builds cash value and has a level premium, but the cash value is usually placed in one or more funds in a family of mutual funds.
• Gifting – During your lifetime, gifts made to future heirs or charities can reduce the size of your estate, which would reduce the estate taxes due at death.
• Annual Gift Tax Exclusion – allows an individual to gift up to $10,000 per year to as many people as desired free of gift taxes.

 Web Resources on Estate (Death) Taxes

1. Willco.: Estate Planning On-Line http://law-sites.com/estate_and_gift_tax.htm provides low cost estate planning documents on line, information on the most recent estate and gift tax legislation, and examples of the how some trusts work.
2. EstateWeb http://www.estateweb/common/taxes.com provides background on options for reducing estate taxes with effective planning techniques as well as an "Estate Tax Calculator" for determining what your current estate tax bill might look like.
3. Fidelity: How the new tax rules change estate and gift taxes http://www.fidelityatwork.com/401k/pfp/wisdom/pond9397.htm provides a snap shot of the current estate tax exemptions and more detailed information on family-owned businesses.
4. New England Financial http://www.nefn.com/Content/Needs/estate/estcnsdr.cfm provides estate as well as business planning while addressing states that currently impose estate taxes.
5. WMO Atlanta Law http://www.atl.mindspring.com/~wmo/estatetax.html provides explanations for why changes in federal gift and estate tax structures mean greater wealth for future generations.