|
|
|
|
The Family-Owned Business Exclusion May Provide Significant Estate Tax SavingsBy: Danny VessThe Taxpayer Relief Act of 1997 provides business owners with an extra exclusion to protect their estate from taxes. The Family-Owned Business Exclusion allows a decedent to exclude all or a portion of a “qualified family owned business” from estate taxes. There are many criteria, which must be met to qualify for the Family-Owned Business Exclusion. The most basic requirements are:
· The business must be a proprietorship (wholly owned by decedent) or the decedent and his family must hold a 50% or greater share of the business (if the business is a partnership, corporation or limited liability company.)
· The value of the family business interests owned by the decedent and/or the value of the interests given away to family members must be greater than 50% of the decedent’s adjusted gross estate (the property owned by the decedent at death plus the value of all lifetime taxable gifts).
· During the eight years preceding his death, the decedent or a member of the family must have operated the business for periods aggregating in five years.
· To avoid recapture of estate taxes, a qualified heir (sibling, child, niece, nephew of the decedent or his spouse or any active employee of the business if such employee has been employed by the business for a period of at least 10 years before the date of the decedent’s death) must materially participate in the business for ten years following the decedent’s death.
· The executor must elect the exclusion and file an agreement made by the qualified heirs to be subject to recapture taxes.
The amount of the exclusion is tied to the exclusion amount of the unified credit. The Family-Owned Business Exclusion along with the unified credit may allow a decedent to exclude up to $1,300,000 from estate taxes ($2,600,000 per married couple).
Example (1): D, a widower, dies in 2000. His estate is valued at $1,300,000. A majority of the value of his estate is a closely held business in which he is the sole shareholder. D and his son ran the business for over five years before D’s death. D’s son continues to run the business for over 10 years after D’s death. D’s exclusion under the unified credit is $675,000. D’s maximum available Family-Owned Business Exclusion is $625,000. D’s estate will not owe federal estate taxes or state inheritance taxes. Without the Family-Owned Business Exclusion, D’s estate will owe $249,250 in federal estate taxes and state inheritance taxes.
Example (2): Same as above, except D dies in 2006. D’s exclusion under the unified credit is now $1,000,000. D’s maximum available Family-Owned Business Exclusion is $300,000. The tax consequences are the same.
The Family-Owned Business Exclusion can be an immensely valuable tool in planning your estate. However, because the qualifications for the family owned business exclusion is complex and may require meticulous documentation. Please feel free to contact us for planning advice regarding the disposition of any interests in your family-owned business.
Texas Law Allows Spouses to Convert Separate Property into Community PropertyBy: Danny VessAn amendment to the Texas Constitution approved by voters on November 2, 1999 allows spouses to convert separate property into community property. The new law became effective January 1, 2000. Separate property consists of property owned by either spouse before marriage or property acquired during marriage by gift or inheritance. Community property is property, other than separate property, acquired during marriage.
A conversion of separate property into community property can only be made written agreement signed by both spouses. The agreement must be made during marriage (no pre-marital conversion agreements). Only property owned by either spouse at the time of the agreement can be converted.
This new law may present several significant planning opportunities for Texans.
· All community property assets receive a new basis (for income tax purposes) equal to the fair market value on the day the decedent spouse died. Separate property assets owned by a surviving spouse do not receive a new basis.
· Converting separate property into community property will most likely insure that each spouse will have sufficient assets to make full use of their unified credit. (The current unified credit exclusion is $675,000.)
Example: Harold and Wilma are married and live in Dallas, Texas. They have two adult children. Harold’s late aunt left him 2,000 shares of XYZ stock in 1999. Harold’s new basis in the stock was $100 per share. Since Harold inherited the stock from his aunt, the stock is Harold’s separate property. Harold decides not to convert the stock to community property. Later that year, XYZ’s new website XYZ.com sent the stock to $500 per share. Shortly thereafter, Wilma passed away. Wilma owned separate property worth $25,000 and she and Harold owned $800,000 of community property. As a result, Wilma’s taxable estate is only $400,000, which is not enough to fully utilize her unified credit. Wilma and Harold have lost the opportunity to transfer another $250,000 to their children free of estate taxes.
Two months later, Harold decides that he wants to invest in hot new donut franchise. Harold decides to sell his XYZ stock ($500 per share) in order to buy his share of the franchise. When Harold sells the stock, his basis is $100 per share. His capital gain is $800,000. If the stock had been community property, his new basis would be $500 per share and his capital gain would be zero.
There are also some disadvantages to converting separate property into community:
· Community property is subject to “just and right division” upon divorce. Separate property belongs to the owner spouse upon divorce.
· Separate property of one spouse is protected from creditor claims against the other spouse. By changing separate property to community, you lose that creditor protection.
QPRT’s Can Provide Significant Tax Savings in the Right ScenarioBy: Danny VessA Qualified Personal Residence Trust (QPRT) is established by donating a personal residence to a grantor trust in exchange for the right to live in the house for a term of years (trust term). This allows the grantor to transfer his residence at a reduced rate of tax. The principal concern in creating a QPRT, is that the grantor will die during the trust term. This would cause the residence to be brought back into the estate for tax purposes. For this reason, it is very important to consider the age and health of the grantor when creating a QPRT. When a QPRT is created the grantor retains the right to live in the house for the trust term and makes a taxable gift of the remainder interest in the residence to the beneficiaries. The house’s fair market value, the age of the grantor(s) and a fraction taken from the Treasury’s actuarial tables determine the value of the remainder interest. The grantor is taxed on the transfer of the remainder interest to the beneficiaries. This transfer is not subject to the $10,000 annual gift tax exclusion. If the personal residence in question is community property, then there must be gift by each spouse to the QPRT or they can each donate to a separate QPRT. Another important factor to consider is the taxable basis in the personal residence. When the residence is transferred through the QPRT, it is a lifetime gift. Therefore, the beneficiaries’ basis in the house is the same as the donor’s basis. However, if the residence is transferred by a surviving spouse, the basis the will be stepped up to the date of death value of the first spouse to die. |
|
Send mail to legalcpa@aol.com with questions or comments about this web site.
|
