Frontier -- Your Money
After You're Gone
Death is still inevitable but taxes and family squabbling can be avoided
The "Death Tax" lives on, but don't shed any tears over Congress' failure last month to repeal the levy. There are plenty of ways to pass a small business to your heirs without taking a mortal hit on estate taxes (more on that in a minute). What will really kill your company is a related problem that you have to outlaw yourself: squabbling among your family over who's in charge. The fact is, estate and succession planning go hand in hand for a family business.
Just ask Robert Seastrom, president of Seastrom Manufacturing Co., a maker of aerospace equipment in Twin Falls, Idaho. His grandfather, who started the business in 1928, left it to his two sons, Wesley and Donald. Their four children, two from each family, joined the company after college. Suddenly, with six Seastroms among 70 or 75 employees, no one knew who was giving orders, Robert says. One group of Seastroms, including Robert, wanted to expand; the others liked things the way they were. The family started bickering--inside and out of the office. Robert, the youngest and lowest on the totem pole, resigned. Wesley asked Donald to buy him out. Holidays were a disaster--nobody wanted to talk to anybody--and trying to run the company was an exercise in frustration. "I don't mind hindering my own progress, but I really don't like it when somebody does it for me," Robert says. Finally in 1989, Wesley and Robert bought out Donald's contingent.
With the deal done, Wesley made sure there would be no repeat performance when he died: He began transferring not only his majority stake, but also management, to his son. The goal was to avoid an excessive bill for taxes and an excessive tumult for operations.Just in time. The move proved sage and timely. Three years later, Wesley died in his mid-60s of a heart attack. Estate taxes weren't an issue; his remaining company stock went tax-free to his wife, Marea. She has continued to pass minority interests to her son and other family assets to her daughter, and Robert has become the new boss.
That sounds pretty seamless, but if not for Wesley's two-pronged planning, there would be no business today, Robert maintains.
No two family businesses are the same, and each case raises different questions, says Joel Goldhirsh, a financial adviser in Irvine, Calif. "Is there another family member involved in the business?" Goldhirsh asks. "Is the owner going to die with his boots on, or does he or she want to have an exit strategy? If they want an exit plan, do they want to do it with another family member or some other key employee?"
Once those decisions are made, saving taxes--particularly when you have some time--is a snap. Federal law allows you to transfer $10,000 in assets each year to any one person. If you have 10 heirs, that means you can transfer $100,000 in assets annually, and if you're married, your spouse can give another $100,000. Better yet, minority interests in an illiquid asset, such as a family business, are theoretically less valuable and thus get discounted, says Philip J. Holthouse, partner at the Los Angeles tax law and accounting firm Holthouse Carlin & Van Trigt LLP. The precise amount of the discount depends on a number of factors, including whether there are restrictions on the eventual sale of the stock. However, the bottom line is that you can transfer a large amount of value without generating estate or gift tax--and without running afoul of the Internal Revenue Service.High hurdles. Better yet, if you are leaving a business to a family member who intends to run it--the Seastrom model--there are special provisions in the tax code carved out just for this purpose. In 1998, new rules doubled the amount of "qualified family-owned business interests" that could be left to heirs tax-free. The upshot is that while an average person can leave $675,000 in assets to the heirs tax-free, some family-business owners can bequeath about $1.3 million without facing federal estate taxes.
Not everyone qualifies, though, and some hurdles are particularly high if you're already pretty old. Here's why: The decedent--let's assume it's you--must be a U.S. citizen and have more than 50% of his or her assets tied up in the family enterprise. That's not too onerous for most entrepreneurs. But on top of that, you must leave the business to a "qualified heir"--defined as a family member or someone who was employed by the company for at least 10 years prior to your death, according to CCH Inc., a tax-research and publishing company in Riverwoods, Ill. What's more, the successor has to stay on for a prescribed period. Family heirs face the same problem: They must have been involved in the family business for at least 5 of the 8 years prior to your death, and remain locked in as participants for at least 5 years during the 10 years after you're gone.
Translation: Don't die too soon after naming your successors, and don't let them quit too soon after you do die, or else the tax deal is off.
If you can get past these scheduling issues, your reward is another tax break. Estate taxes attributable to the business stake can be deferred for four years, during which time only interest must be paid, says Goldhirsh--and that's calculated at a below-market rate.
Most businesses would be wise to use other methods, such as buying life insurance or systematically transferring minority stakes to heirs, Goldhirsh explains. Why? Because the heirs have more flexibility. For starters, systematic transfers can reduce or even eliminate the tax. If that's not enough, life insurance provides ready cash to cover taxes, so your heirs don't have to dip into company resources. What's more, the proceeds can liberate your duly anointed "qualified heirs" if they really don't want to stick around for five years after you're dead. Their departure would still trigger a huge bill for back taxes if you previously claimed the family business tax break, but the policy would absorb the blow.
Experience has taught Robert Seastrom, 39, not to leave his estate- or corporate-succession planning to chance. He is already transferring some ownership to his sons, Ryan, 10, and Daniel, 6. But, since he doesn't know whether the boys will grow up to be interested in the business, he's also changing the company's structure. "We are going to be issuing stock to key employees to ensure their ownership and their willingness to help grow the company," Robert says. "The company will move on, regardless of whether there's a Seastrom here or not." That's smart planning: You can't take it with you, but there'll be more to enjoy while you're still around.Click Online Extras at frontier.businessweek.com for a guide to succession planning.By Kathy Kristoff; Kristof Is the Personal Finance Columnist for the Los Angeles Times.Return to top