By: A.J. Cook


Will IRS Inherit Your Business? Now It's Easier to Keep It in the Family.

Family-owned businesses including farms often have been dealt a murderous blow when the owner died. The mortality rate for passing firms from the first generation to the next stands at 70 percent.

These family businesses are often killed by estate taxes, taxes on assets people own when they die. Many owners, millionaires on paper, are cash poor so the heirs must liquidate the business to pay taxes.

The new tax law alleviates the problem somewhat by reducing the volume and velocity of death taxes. One change helps the business owner and nonowner alike. The law increases the exclusion available to everyone from $625,000 this year to $1 million in 2006. This won't effect you, right? Think again. Anyone who owns a home, a pension plan, a few investments and a life insurance policy is probably above the exclusion. Add a business to these and you usually top out well over the exclusion.

Here are three tax laws intended to help perpetuate the family business:

1. People who die this year won't care, but their heirs might see the first $675,000 of value in the family business excluded from taxation. This exclusion is in addition to the $625,000 general exclusion, for a total of $1.3 million. Only Congress could dream up how these numbers change in the next few years. As the general exclusion increases incrementally to its $1 million peak in 2006, the business exclusion drops by the same amount so that both continue to total $1.3 million.
   
   
2. The special use valuation also should be mentioned. Sometimes real estate used in farming or other closely held businesses can get a reduced valuation, which in turn reduces estate taxes. It can be valued at a sometimes lower amount based on how its used rather than what it can be sold for. A working farm next to a growing shopping center could be valued as farmland, not as a potential extension to the mall. Or, property used as a parking lot could be valued as a parking lot and not, as the Internal Revenue Service has done, valued it at its best use – say, for the construction of an office complex or apartment building. The reduction in value is limited to $750,000.
   
   
3. Finally, after the tax breaks and exclusions are considered and it's time to pony up, the heirs do not have to pay at breakneck speed. Estate taxes due from a closely held business may be paid in installments over as many as 14 years. Also, the tax on the first $1 million in value may be eligible for low interest rates.
   

As with all things federal, qualification requirements for these special deals are numerous and imponderable, and no one should go gently into that good night without a tax advisor. One major hurdle for qualification is that the business interest included in the estate must be 35% of the total estate for the installment benefits and 50% for the other benefits. An estate worth $3 million will meet one of the family business requirements if the business interest included is worth more than $1.5 million. The form of the business is unimportant; it can be a corporation, partnership, limited liability company or a sole proprietorship.

If from these three laws you see an opportunity, check with your tax advisor for the particulars and what you can do to qualify.

The Moral: The new tax law takes some worry out of dying for everyone except the deceased.

A.J. Cook is a lawyer and CPA. His tax column appears weekly in numerous newspapers. Why isn't it published in your hometown newspaper? Ask its Business Editor to subscribe.

Copyright © 1987-2001 A.J. Cook All Rights Reserved
This information is not intended for use without professional advise.
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Released 1-12-98