Small Business Tax Solutions
What impact does the family-owned business exclusion -- signed into law by President Clinton on August 5, 1997, as part of the Taxpayer Relief Act of 1997 -- have on succession planning for family businesses? Family business start-ups began to surge following the en of World War II. Now, 50 years later, as the founders either retire or die, these businesses are being passed on to the next generation. This has created a crisis for businesses that had long been stable and has put Congress under pressure to ease the potentially devastating impact of estate taxes on the survival of these businesses. Congress provided family businesses with partial estate tax relief in TRA 1997 by enacting Internal Revenue Code section 2033A -- the family-owned business exclusion. OVERVIEW OF THE PROVISIONS The new exclusion may reduce the gross estate of business owners by the lesser of (1) the adjusted value of the decedent's qualifying family-owned business interests otherwise includable in the estate of (2) the difference between $1.3 million and the applicable exclusion amount of the unified credit for the estate. For example, if the founder of company X dies in 1998 when the unified credit exempts $625,000 from tax an the adjusted value of her business interest is $1 million, the exclusion amount would be $675,000 ($1,300,000 -- $625,000). If the adjusted value of her business interest is $500,000, the exclusion would be limited to $500,000. Its is important for practitioners to note that the family-owned business exclusion applies in addition to the IRC section 2032A special use valuation and section 6166 installment payment provision. Qualifying business interests. A family-owned business interest qualifies for relief if it is a trade or business interest in either a proprietorship or an entity of which 50% is owned by the decedent and members of his or her family, 70% is owned by members of two families or 90% is owned by members of three families. For an interest to qualify under the 70% or 90% tests, at least 30% of the entity must be owned by the decedent and members of his or her family. In the case of a corporation, the ownership test is based on the decedent's family owning a requisite percentage of the total combined voting power of all classes of stock entitled to vote and the total value of all shares of all classes of stock. In the case of a partnership, the ownership test is based on the decedent's family owning a requisite percentage of both the capital interests an the profit interests in the partnership. Nonqualifying business interests. In addition to defining the business interests that qualify as family-owned business interests, the new code section defines business interests that specifically do not qualify, including * Any interest in a trade or business with its principal place of business outside the United States. * Any interest in an entity if its stock or securities were publicly traded at any time within three years of the decedent's death. * Any interest in a business other than a bank or domestic building and loan association if more than 35% of its gross income in the year of the decedent's death would qualify as personal holding company income (dividends, interest, royalties and other investment-type income pursuant to IRC section 543(a)). …