If you own a sizable family business, some big changes are coming to how that business can be passed down from one generation to the next, thanks to the IRS. It’s important to understand what’s changing and why, and how you can be ready when the time comes to help keep that family business alive.
What’s the current situation?
It’s pretty straightforward and mostly affects wealthier families, or about two out of every 1,000 estates, according to the Center for Budget and Policy Priorities. Under current law, if a family member dies, and their business assets are valued above $5.45 million (or $10.86 million per couple), the federal estate and gift tax rate is a whopping 40 percent (assets below that are free of the federal estate tax). Because of that huge tax burden, families are always looking for ways to reduce the transfer taxes on a business to family members.
Is this really a big deal?
Yes, for many reasons. Estate taxes, which are typically due within a year after the date of a death, can be enormous. And if a family isn’t prepared for them, they can paralyze a family business or lead to financial ruin. One commonly cited example came in 1990, when the founder of the Miami Dolphins football team, Joe Robbie, died, and a $47 million estate tax bill forced his family to sell the franchise.
So how do families actually get around this?
One of the more common legal tricks to lower the transfer taxes is to discount the interest in the business. If the business owner shifts a minority stake in the business to their children, for instance, the law allows the business owner to claim that their children’s stake should be discounted because they lack marketability or they can’t control the operations. That discount can be significant, sometimes as much as 20-40 percent lower than the original rate. It’s real savings.
The IRS allows that?
The law allows it. The IRS doesn’t like it. Which is why we’re having this discussion.
Why doesn’t the IRS like it?
Not surprisingly, more people are trying to take advantage of that loophole, in ways that aren’t always kosher. “People have gotten aggressive utilizing these discounts without proper support and perhaps that’s why they are under attack,” says Andrew Bostian, a senior appraiser at BlumShapiro. “But in most cases, there are supporting empirical studies for the discounts.”
OK, so explain the changes coming.
The Internal Revenue Service has proposed eliminating valuation discounts for estate planning and family-controlled businesses, based on marketability or lack of control. The regulations would take place sometime after December 1, 2016. If they’re adopted, the new rules would significantly reduce those discounts on transfers of interests in closely-held family business entities, such as limited partnerships, limited liability companies, and corporations. Bostian estimates that if the proposed regulations are adopted as written, they could increase the tax burden on a family business by as much as 50 percent.
So for any family that might be affected by this change, what should they do?
Good question. In the next 60 days, before the IRS holds hearings on these changes on December 1, here are some key steps to guard against the effects of the changes, based on research and conversations with family planning experts:
Is that it?
Not quite. Will the new regulations be retroactive? Will the discounts be eliminated or reduced? There are still some unanswered questions.
For over a century, Rockland Trust has built relationships with business owners to fuel their success and growth. We believe that bond begins with us listening to each of our customers. Together we’ll find the best solutions to help your business’ specific financial objectives.