Preserving the Family Legacy: The Estate Tax "Repeal" Doesn't Eliminate the Need for Succession Planning
EXECUTIVE SUMMARY * TO HELP FAMILY BUSINESS OWNERS BUILD A LEGACY, CPAs need to help family members develop a plan to transfer the business to the next generation while minimizing estate, gift and income taxes. Although the 2001 tax act eliminates estate taxes in 2010, there is no guarantee the repeal will be permanent. * USING THE INSTALLMENT SALE STRATEGY, the senior family member sells the business to a younger member for a fixed series of payments at least one of which is received in a future tax year. The senior member recognizes a gain each year he or she receives payments. As long as the purchase price is fair and the note bears a reasonable rate of interest, there are no gift tax consequences. * WITH A SELF-CANCELING INSTALLMENT NOTE (SCIN), the junior family member promises to make periodic payments until the senior member receives the sale price or dies, whichever occurs first. To compensate the senior member for the risk he or she will die before receiving full payment, the SCIN includes a risk premium in the form of a higher purchase price or interest rate. * CPAs CAN ALSO RECOMMEND THE SENIOR FAMILY member sell the business via a private annuity in exchange for the junior member's unsecured promise to make payments for the duration of the senior's life. This kind of transaction includes elements of both a sale and an annuity and is taxed accordingly. * WITH A GRANTOR RETAINED ANNUITY TRUST, the senior member transfers the business to a trust and retains an income interest for a specified number of years. When the trust term ends, the business passes to the junior member. This strategy gives the senior member an income stream while he or she continues to control the business. Building a family business into a legacy demands that families plan for succession. A business owner's key objective in developing such a plan is to transfer the greatest amount of wealth to the next generation at the least possible tax cost. In addition to minimizing estate, gift and income taxes, the transfer also must provide the senior family member, who may lack sufficient resources other than the family business, with adequate sales proceeds or a lifetime income stream to continue to live comfortably. The estate-tax-repeal provisions included in the Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA) may lead some clients to believe they no longer need to plan for the transfer of a family business. As CPAs realize, however, those who dismiss estate planning because of the act are reading the headlines only--not the fine print. Exhibit 1, page 37, shows the so-called estate tax repeal doesn't take effect until 2010 and continues thereafter only if Congress votes to override EGTRRA's sunset provisions. The result is that complete estate tax repeal is a remote and short-lived possibility. Thus, CPAs need to warn clients of the danger of adopting a "wait until repeal" policy. Minimizing the estate and gift tax cost of passing the family business to the next generation continues to warrant active planning. This article highlights four strategies that are capable of helping a family business minimize transfer tax costs as well as meet the needs of the senior family member: * Installment sale. * Self-canceling installment note. * Private annuity. * Grantor retained annuity trust. Each of these strategies has advantages and disadvantages that CPAs can explain to clients trying to develop succession plans. With the dim prospects for estate tax repeal, these techniques are little changed and remain viable ways to preserve the family legacy. INSTALLMENT SALES Under the installment sale strategy, the senior family member (the business owner) sells his or her business to a younger family member for an interest-bearing promissory note requiring a series of fixed payments, at least one of which will be received in a future tax year. …