In last month’s article, entitled “Now is the Time for Tax-Efficient Wealth Transfers,” we discussed why now is an excellent time for tax-efficient wealth transfers because depressed asset values and historically low interest rates offer unique opportunities to leverage assets and minimize gift, estate and income taxes. This article addresses why it is important to critically review business owner estate plans (and taxable estate plans) before December 31, 2009.
It is no secret that (i) federal expenditures are unprecedented, (ii) federal tax revenues are insufficient, and (iii) the new administration’s revenue neutral and wealth redistribution policies advocate tax law changes aimed at generating substantial tax revenues from the wealthy. Let’s take a look at current and proposed tax law changes that should urge any business owner and individual with assets (including life insurance) in excess of $1M to critically review their estate plan.
Elimination of Minority Interest Discounts for Family Businesses—Proposed legislation eliminates the use of valuation discounts (lack of control and lack of marketability discounts) in certain family-owned businesses. The denial of valuation discounts could result in significantly higher estate and gift taxes for many business owners because these discounts often reduce the value of transferred assets by as much as 20 percent to 40 percent.
For example, if father gifts daughter a 20 percent ownership interest in a family business valued at $8 million:
• under current law, father’s gift does not trigger federal gift tax liability. Why? Because if father’s gift receives a 24 percent lack of control discount and an 18 percent lack of marketability discount resulting in a $997,120 gift to daughter, then since father’s gift is less than $1,000,000 (the federal gift exemption), the gift does not trigger any federal gift tax liability.
• under proposed law, father’s gift generates a $270,000 federal gift tax liability. Why? Because if father’s gift receives no valuation discounts resulting in a $1,600,000 gift to daughter, then since father’s gift is greater than $1,000,000 (the federal gift exemption), the excess gift over $1,000,000 is a taxable gift which generates a $270,000 federal gift tax liability.
Even if valuation discounts are not eliminated for gifts of family business interests, given the nation’s deficit, expenditures, and revenue neutral fiscal policies, it is likely that current valuation discounts will be replaced with more conservative discounts resulting in higher taxes via higher estate and gift tax values. Greater gift tax values will result in smaller gifts being made, which in turn result in less asset appreciation shifted to the next generation and out of the taxpayer’s estate.
Reduction in Estate Tax Exemption—Unless new estate tax laws are adopted, the 2011 federal estate exemption (the most that a taxpayer can pass estate-tax-free to someone other than a surviving spouse) will be reduced from the current $3,500,000 to $1,000,000, which may leave unwary taxpayers with huge estate tax liabilities.
Increased Highest Marginal Estate Tax Rate—Current estate tax law increases the highest marginal federal estate tax rate from 45 percent to 55 percent in 2011. The increased tax rate combined with the reduced estate exemption can generate significant estate taxes from estates that otherwise would have been non-taxable.
Now consider the combined federal tax implication of the (i) government’s unprecedented spending and revenue neutral fiscal policies, (ii) elimination of certain valuation discounts, (iii) reduced estate tax exemption, and (iv) increased estate tax rates.
For example, if at the time of father’s death, father owns a 45 percent ownership interest in a family business that is valued at $12 million:
• under current law, father’s 45 percent ownership interest does not trigger federal estate tax liability. Why? Because if father’s 45 percent ownership interest receives a 22 percent lack of control discount and a 17 percent lack of marketability discount resulting in a $3,495,960 value included in father’s estate, and if father’s total estate is less than $3,500,000 (the 2009 federal estate exemption), then father’s estate does not trigger federal estate taxes.
• under proposed law, father’s 45 percent ownership interest triggers significant federal estate tax liability. Why? Because if father’s ownership interest receives no valuation discounts then the entire $5,400,000 value is included in father’s estate, and since father’s estate is greater than $1,000,000 (the 2011 federal estate exemption), the $4,400,000 excess over the $1,000,000 exemption is taxable, triggering more than $2,000,000 in federal estate taxes.
Elimination of Certain Tax Planning Techniques—Legislation has been proposed to eliminate certain tax planning techniques after 2009. Thus, if you wait until after December 31, 2009, for estate tax planning, fewer options will be available to you, which could result in significantly higher estate and/or gift taxes.
In summary, a critical review of your estate plan before December 31, 2009, may save your estate millions in tax dollars.
Danica L. Little, J.D., C.P.A., C.M.A., C.F.M., is an attorney with Wishart, Norris, Henninger & Pittman, P.A., a law firm with offices in Charlotte and Burlington serving businesses and business owners, institutions, and professionals. Contact her at 704-364-0010 or visit www.wnhplaw.com.