Estate Planning The graveyards are full of indispensable men and women. Charles De Gaulle Death is not the end; there remains the litigation. Ambrose Pierce I’m not afraid to die. I just don’t want to be there when it happens. Woody Allen

Estate Planning Balancing of control and estate tax issues –Early transfer can minimize estate taxes, but founder will usually want to retain controlling interest until retirement or death

Succession Planning Planning the transfer of business assets to minimize estate taxes is the easy partPlanning the transfer of business assets to minimize estate taxes is the easy part True challenge is developing appropriate succession planTrue challenge is developing appropriate succession plan –Aronoff and Ward term this “The Final Test of Greatness” “The Final Test of Greatness”

Ownership Control Transfer all or controlling interest to one family memberTransfer all or controlling interest to one family member –Can equalize treatment to other children with bequests of other assets Transfer to many family membersTransfer to many family members –Forces issue of building consensus –Some may be passive owners How should passive owners be compensated? –See Cargill article

Controlling Transferability Right of first refusal - company has first right to buy back stockRight of first refusal - company has first right to buy back stock Funded buy-sell agreementsFunded buy-sell agreements –Redemption - purchase by business –Cross-purchase - Agreement among owners Valued using agreed-upon methodsValued using agreed-upon methods –Usually funded with life insurance

Estate and Gift Taxes Assets transferred by gift or bequest are subject to tax Tax is levied on a cumulative, unified basis (lifetime gifts and bequests are combined)Tax is levied on a cumulative, unified basis (lifetime gifts and bequests are combined) Unified credit is allowed, equivalent to an exemption of $650,000 on assets transferredUnified credit is allowed, equivalent to an exemption of $650,000 on assets transferred –Exemption increases to $1,000,000 by year 2006 (1997 Taxpayer Relief Act) Tax rates range from 37% to 55%Tax rates range from 37% to 55%

Marital Deduction There is an unlimited marital deduction from the gross estate for gifts or bequests to a surviving spouseThere is an unlimited marital deduction from the gross estate for gifts or bequests to a surviving spouse It is preferable not to make unlimited use of the marital exclusion and transfer all assets to surviving spouseIt is preferable not to make unlimited use of the marital exclusion and transfer all assets to surviving spouse –Better to use unified credit in both estates Example: Husband dies with estate of $1,200,000 Husband dies with estate of $1,200,000

Estate Planning Example Husband’s Estate (A) (B) Adjusted gross estate $1,200,000 $1,200,000 Marital deduction (1,200,000) (600,000) Taxable estate ,000 Estate tax before credit -0- $192,800 Unified credit (192,800) (192,800) Estate Tax

Estate Planning Example Wife’s Estate (A) (B) Adjusted gross estate $1,200,000 $600,000 Marital deduction N/A N/A Taxable estate 1,200, ,000 Estate tax before credit $427,800 $192,800 Unified credit (192,800) (192,800) Estate Tax $235, Deloitte & Touche, LLP

Estate and Gift Taxes Although estate taxes apply at relatively low asset levels, comparatively few estates are subject to tax due to effective planning opportunities to mitigate tax There is an annual gift exemption of $10,000 ($20,000 joint) per doneeThere is an annual gift exemption of $10,000 ($20,000 joint) per donee –$10,000 exclusion will be indexed after 1998 A series of gifts provides for significant transfers and reduction in the taxable estateA series of gifts provides for significant transfers and reduction in the taxable estate

Gifts Can provide for transfer of control of businessCan provide for transfer of control of business –Value of the $10,000 exemption is greater earlier in the life of the business Lifetime transfers of business interests may result in reduction in controlLifetime transfers of business interests may result in reduction in control –Not a concern if owner maintains controlling interest

Basis Gifts - Carryover basisGifts - Carryover basis –Value of annual exemption is balanced by carryover basis for gifts transferred –Usually do not want to gift appreciated property –Business interest is an exception because Often the largest single assetOften the largest single asset No intention to disposeNo intention to dispose Bequests - Step-up in BasisBequests - Step-up in Basis

Holding of Property Many couples hold property jointly with right of survivorshipMany couples hold property jointly with right of survivorship –Such property passes directly to the surviving spouse Maximizing step-upMaximizing step-up –Want to make full use of unified credit and step-up in basis –How property is held will affect step-up in basis

Family Business Provisions Estate tax exclusion for qualified family-owned businessEstate tax exclusion for qualified family-owned business –If more than 50% of decedent’s estate consists of a qualified family business interest, executor may elect to exclude up to $675,000 from gross estate –Gradually decreases to $300,000 as estate exemption increases to $1,000,000 (combined amounts = $1,300,000)

Qualified Family Business Qualified Family Business Interest Principal place of business is U.S.Principal place of business is U.S. Owned 50% or more by one family (70% - two families; 90% three families)Owned 50% or more by one family (70% - two families; 90% three families) –Decedent’s family owns at least 30% Decedent (or member of family) materially participated in business for five of the eight years before decedent’s deathDecedent (or member of family) materially participated in business for five of the eight years before decedent’s death –Qualified heir must also meet participation standards

Installment Payment of Estate Taxes - Family Business Interests Executor may elect to pay estate tax attributable to a family business interest over 14 years Interest rate is 2% for deferred estate tax attributable to first $1,000,000 in taxable value of closely-held businessInterest rate is 2% for deferred estate tax attributable to first $1,000,000 in taxable value of closely-held business Interest rate is 45% of rate applicable to underpayments of tax for deferred estate taxes attributable to taxable value of closely-held business in excess if $1,000,000Interest rate is 45% of rate applicable to underpayments of tax for deferred estate taxes attributable to taxable value of closely-held business in excess if $1,000,000

Life Insurance Life insurance is one common mechanism for funding estate taxesLife insurance is one common mechanism for funding estate taxes Ownership of policies is criticalOwnership of policies is critical –Although life insurance proceeds are not includable in income, the proceeds will be included in your estate if you are the policy owner. –Policy should be owned by the beneficiary; existing policies should be gifted to the beneficiary

Wills Wills are always a good ideaWills are always a good idea Will dictates what happens to property you own individually, and that does not have a named beneficiary.Will dictates what happens to property you own individually, and that does not have a named beneficiary. –Jointly-held property passes directly to other owner –Property with named beneficiary (IRA, life insurance) passes directly to beneficiary Subject property will pass according to state law if you die intestate (without a will)Subject property will pass according to state law if you die intestate (without a will)