Family-Owned Business Deduction Chapter 42 Tools & Techniques of Estate Planning Copyright 2011, The National Underwriter Company1 What Is The Qualified Family-Owned Business (QFOB) Deduction? The deduction has been repealed from 2004 to 2009 as the estate tax exemption equivalent increased above $1,300,000 –The estate tax is repealed for one year in 2010 The QFOB deduction will return along with the estate tax in 2011 The QFOB deduction applies only to the federal estate tax

Family-Owned Business Deduction Chapter 42 Tools & Techniques of Estate Planning Copyright 2011, The National Underwriter Company2 The deduction is available for up to $675,000 of qualified family owned business interests If the deduction is taken, the estate tax unified credit exemption equivalent is equal to the lesser of –The regular unified credit exemption equivalent, or –$1,300,000 minus the deduction The deduction is subject to recapture if the qualified heirs dispose of the interest or fail to materially participate in the business within 10 years after decedent’s death What Is The QFOB Deduction? (cont’d)

Family-Owned Business Deduction Chapter 42 Tools & Techniques of Estate Planning Copyright 2011, The National Underwriter Company3 When a substantial portion of the estate will consist of an interest in a family-owned business, and When the decedent or decedent’s family has materially participated in the business for five of the eight years preceding decedent’s death, and When the intention is to pass the business on to “qualified heirs” who will continue to operate it for 10 years following the decedent’s death When Is Use Of The QFOB Deduction Appropriate?

Family-Owned Business Deduction Chapter 42 Tools & Techniques of Estate Planning Copyright 2011, The National Underwriter Company4 Decedent must die in or after 2012 Decedent must have been a U.S. citizen or resident at death The executor must elect the application of the IRC Section 2057 QFOB deduction with the estate tax return Value of all qualified business interests, plus certain gifts made of such interests, must exceed 50% of the adjusted gross estate What Are The Requirements?

Family-Owned Business Deduction Chapter 42 Tools & Techniques of Estate Planning Copyright 2011, The National Underwriter Company5 A “qualified family owned business” is defined as either –a proprietorship, or –an interest in an entity carrying on a trade or business In the case of a trade or business –50% of the entity must be owned by the decedent and the decedent’s family, or –70% by two families or 90% by three families For the 70% and 90% tests, the decedent and the decedent’s family must own at least 30% of that entity –The decedent’s family must have materially participated in the business –Interests held by entities, including trusts, are subject to special attribution rules What Are The Requirements? (cont’d)

Family-Owned Business Deduction Chapter 42 Tools & Techniques of Estate Planning Copyright 2011, The National Underwriter Company6 A “qualified family owned business interest” does not include: –A business whose principal place of business is outside the U.S. –Any business whose stock or securities was readily tradable within three years of decedent’s death –Any business with more than 35% of its adjusted gross income from personal holding company income in the tax year of decedent’s death –That portion of a business interest attributable to assets which produce personal holding company income (domestic or foreign) –That portion of a business interest attributable to excess working capital What Are The Requirements? (cont’d)

Family-Owned Business Deduction Chapter 42 Tools & Techniques of Estate Planning Copyright 2011, The National Underwriter Company7 The QFOB interest must pass to a “qualified heir” which includes: –members of decedent’s family, and/or –an individual employed by the trade or business for at least 10 years prior to the decedent’s death Recapture events to avoid within 10 years after decedent’s death but before the death of qualified heirs: –failure of an heir to participate in the business for at least 5 years out of any 8 year period, –loss of U.S. citizenship by an heir, or –disposition of the business, other than to a family member or through a qualified conservation contribution What Are The Requirements? (cont’d)

Family-Owned Business Deduction Chapter 42 Tools & Techniques of Estate Planning Copyright 2011, The National Underwriter Company8 Charles and his two children are the only shareholders of Nuts-4-U, Inc. At Charles’ death in 2003, his gross estate equaled $1.8 million Charles left his interest in Nuts-4-U, Inc. valued at $1.4 million to his children Charles had previously made annual exclusion gifts of Nuts-4-U, Inc. stock valued at $40,000 to his children At his death, Charles owed $60,000 on a mortgage and had $12,000 of other debt How It Is Done – An Example

Family-Owned Business Deduction Chapter 42 Tools & Techniques of Estate Planning Copyright 2011, The National Underwriter Company9 Adjustments To Business Value Value of Qualified Family Owned Business Interest$1,400,000 Plus: Gifted Business Interests40,000 Less: Total Debts($72,000) Subtract from Total Debts (Line 3): Residence debt to extent deductible under IRC$60,000 Qualified educational/medical expense debt0 Other debts ($10,000 cap)10,00070,000 Total Debt Adjustment (Line 3 – Items in 4)(2,000) Adjusted Value of Qualified Family Owned Business Interest $1,438,000 How It Is Done – An Example (cont’d)

Family-Owned Business Deduction Chapter 42 Tools & Techniques of Estate Planning Copyright 2011, The National Underwriter Company10 Gross Estate For Qualified Family Owned Business Purposes Gross Estate (including business)$1,800,000 Less: Usual Deductions (debts, administration, etc.)(100,000) Adjusted Assets$1,700,000 Plus Gifts: Gifted business interests$40,000 Gifts to spouse within 10 years of death0 Non-business gifts over $10,000 within 3 years of death040,000 Gross Estate for Qualified Family Owned Business Purposes$1,740,000 How It Is Done – An Example (cont’d)

Family-Owned Business Deduction Chapter 42 Tools & Techniques of Estate Planning Copyright 2011, The National Underwriter Company11 Calculating Eligibility For The Deduction 50% of Gross Estate (from Figure 42.2) (if less than next line, estate is eligible) $870,000 Adjusted Qualified Family Owned Business Interest (from Figure 42.1)$1,438,000 Maximum Deduction675,000 Actual Deduction (lesser of Adjusted Qualified Family Owned Business Interest or Maximum Deduction amount) 675,000 How It Is Done – An Example (cont’d)

Family-Owned Business Deduction Chapter 42 Tools & Techniques of Estate Planning Copyright 2011, The National Underwriter Company12 Decedent’s taxable estate is reduced by the qualified family owned business interest deduction Benefit of deduction is generally recaptured if within 10 years after decedent’s death: –qualified heirs dispose of the interest, or –fail to materially participate in the business Tax Implications

Family-Owned Business Deduction Chapter 42 Tools & Techniques of Estate Planning Copyright 2011, The National Underwriter Company13 A surviving spouse’s interest, whether community property or separate property, is included in the calculation for determining the percentage of the business owned by the decedent All interests owned by the decedent’s family members are included in the 50% ownership test Issues In Community Property States