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Estate/Succession Planning for Business Owners

 Estate Taxes

  • Historical Overview
    • 2001 tax law change
      • Increased exemptions
      • Decreased rates
    • State decoupling
      • Elimination of state death tax credit
  • Federal Estate Tax
    • Current exemption – $3,500,000
    • Current highest rate – 45%
    • 2010 and future predictions
  • New Jersey Death Taxes
    • Estate Tax
      • Exemption - $675,000
      • Maximum rate – 16%
    • Inheritance Tax
      • Classes of beneficiaries
      • Exemptions
      • Maximum rate – 16%

Lifetime Gifting

  1. Annual exclusion - $13,000
    • Per donee exclusion
    • Spousal consent to split
  2. Lifetime gift exemption - $1,000,000
  3. Coordination with estate tax

Estate Planning

  • Outright gift of business interests
    • Discounts – lack of marketability, minority interest, etc.
    • Bifurcate equity ownership
      • Voting control (voting stock, general partner interest)
      • Equity only (non-voting stock, limited partner interest)
  • Intrafamily Sales
    • Installment Sale
    • Self-cancelling installment note (SCIN)
    • Private Annuity
  • GRAT/GRUT – Grantor Retained Annuity Trust or Grantor Retained Unitrust
    • Irrevocable Trust
    • Grantor retains an interest (annuity) for a fixed period of years
    • Remaining principal at the end of the trust term passes to beneficiary
    • Pass assets to next generation with minimal gift tax impact
  • QSST – Qualified Subchapter S Trust
    • Trust must meet requirements to qualify as an S corporation shareholder
    • Income beneficiary of the trust reports S corporation income on his/her tax return
    • QSST works well when objective is to provide income to a beneficiary but not allow beneficiary access/control over corpus (stock)
    • QSST also works well when objective is to provide income to one beneficiary but reserve corpus for another beneficiary following the death of first beneficiary
  • ESBT – Electing Small Business Trusts
    • Allowed to have more than one income beneficiary (can split income amongst several beneficiaries)
    • Distributions of income are not required
    • Trust pays income tax on S corporation income at highest tax rate (35%/15%)
    • Beneficiaries of trust must be eligible shareholders
  • Sale to an Intentionally Defective Grantor Trust (IDGT)
    • Trust is irrevocable (outside of grantor’s estate)
    • Income of trust is taxed to the grantor (transferring more to the beneficiaries this way)
    • Grantor sells business interest to IDGT in exchange for promissory note
      • Payments of interest (no less frequent than annually) for a specified period of time
      • Single balloon payment of principal at end of period
    • Promissory note secured by asset sold to trust
    • Transactions between grantor and grantor trust have no income tax consequence
      • No gain/loss on sale
      • No interest income from trust
    • Gets appreciation out of estate (value freeze at sale date)
  • Irrevocable Life Insurance Trust (ILIT)
    • Remove value of insurance policy from grantor’s estate
    • Provide liquidity for estate taxes
      • Trust can loan money to estate or purchase assets from estate
  • Deferral of Estate Tax Attributable to Closely-Held Business Interest (IRC 6166)
    • Value of closely-held business interest must exceed 35% of the adjusted gross estate
    • Installment payments can be made over maximum of 14 years
      • Interest only for first four years
      • Interest and principal for remainder of deferral period
      • Reduced interest rates apply

Succession Planning

  • Buy-Sell Agreements
    • Provides for purchase of owner’s interest in business by other owners upon first owner’s death/disability/retirement
    • Imposes restrictions on lifetime transfers of interests
    • Creates a market for stock/units
    • Buy-sell agreements are typically part of shareholder agreements, LLC operating agreements or partnership agreements
    • Sales price determined by valuation method in agreement such as:
      • Fixed price per share
        • FMV third-party appraisal
        • Formula approach such as an earnings multiple
        • Book value
    • Cross Purchase Agreement
      • Agreement between individual shareholders/partners
      • Each shareholder purchases a life insurance policy on the lives of all the other shareholders/partners
      • Upon death of shareholder/partner, the other shareholder/partners use life insurance proceeds to purchase deceased’s interest
      • Note: can be cumbersome and expensive if many owners involved and there is a wide disparity in age and insurability of the owners
    • Stock Redemption Agreement
      • Agreement between shareholders and corporation
      • Upon death of shareholder the corporation redeems the deceased’s shares (works for disability also)
      • If corporation owns life insurance on shareholder to fund the redemption then there is an alternative minimum tax (AMT) problem
      • Note: typically more efficient method when there are many shareholders involved
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