Estate planning is essential for all business owners regardless of what happens on Capitol Hill. Tax minimization is only one reason for such planning, although it's the reason that attracts the most attention. No matter what happens to estate-tax rates, if you care about how your assets and your company get distributed after your death, you need a will. If your children are minors, you should address their guardianship. Finally, if you're an entrepreneur who is concerned about your company's long-term survival, you need the equivalent of a corporate will that addresses management succession and related matters.
That said, the uncertainty about estate taxes does suggest certain courses of action, depending on your circumstances. The hypothetical questions and the answers outlined below may help you sort out the alternatives that make the most sense for you and your company.
Q: I'm in the start-up phase but expect my company to grow very big, very fast. Should I begin making gifts now or wait to see how the political debate is resolved?
A: Because of the likelihood of changes in the gift-and-estate-tax exclusion, some business owners should postpone making major gifts or putting large sums into irrevocable trusts, because their estates may fall below the new exclusion limit. But given the accelerated growth profile that you describe, you're not one of them. If you anticipate that your entrepreneurial venture will quickly reach a value greater than, say, $5 million, then think about starting to give away stock soon. If you start early, you may be able to avoid the gift and estate taxes entirely. As long as your company isn't profitable and hasn't yet attracted large-scale investors, its stock could be considered nearly worthless; also, any gift of a minority equity stake in a privately held company gets discounted in value by the IRS, making a gift-tax liability even less likely.
Q: What if I'm uncertain about my growth potential -- and think that the company could stay in the $3-million-to-$5-million range, or even lower?
A: Then it probably makes sense to delay all but the most minor gift-giving activities. The exclusion could easily grow to the point at which you could bequeath that much value at death without the estate's incurring a significant liability. So why deal with the hassles of equity transfers sooner than you want to?
Q: I'm thinking about starting a com- pany, and I anticipate no problem raising private-equity funds, given my résumé, contacts, and turbocharged idea. There's no reason for me to begin estate planning now, is there?
A: Wrong. With or without the involvement of politicians, the world of estate planning has been permanently affected by the superheated capital-market trends of the past few years. Would-be entrepreneurs like you could pass from the private fund-raising stage through an initial public offering or company sale in less than two years. So the best time for estate planning is when you're conducting all the other planning for your company launch. No matter how high the gift-and-estate-tax exclusion gets, it's unlikely that in your circumstances your estate will be under it. So it will pay to do the right kind of planning now.
Q: My company is large and successful, and my estate is potentially liable for a high estate tax. Since I didn't plan ahead, is there anything I can do now, or does it make sense to wait and hope for the best?
A: You're in the worst of all worlds, although you're scarcely alone. In the past -- when the tax situation was clearer and more predictable -- many estate planners would have advised you to bite the bullet and make large gifts to your heirs (or their trusts) right away. That's because of a subtle but significant difference between the way that federal taxes get imposed on gifts versus bequests above the exclusion limits. For instance, if you're in a 50% gift-tax bracket and you gave $1 million worth of stock this year to your daughter, you would owe $500,000 in gift taxes, adding up to a total transfer of $1.5 million. If, instead, you died, leaving that same $1.5 million in assets to your daughter, estate taxes would gobble up roughly $750,000, leaving her with $750,000 -- $250,000 less than she'd get from a gift made during your lifetime.
But these days all bets are off, and few planners are willing to advise their clients to incur significant current tax bills that they might later find they could have avoided. "It makes one quite nervous to contemplate taxable transactions, given the possibility that relief may be in sight at some point in the future," says Laurie J. Hall, whose practice, at Boston's Palmer & Dodge, includes estate planning. "Right now I'd have to advise people to stick to tax-free activities, which would include making their $10,000 annual gifts."
Another strategy that Hall recommends for business owners is making a gift of stock to a GRAT (a grantor-retained annuity trust). "An entrepreneur retains the right to receive back a percentage of the value of the initial stock gift every year for a specified period of time, say three years," Hall explains. "At the end of three years, the stock goes to the entrepreneur's children. For tax purposes the IRS discounts the value of the gift -- the higher the percentage the entrepreneur gets back every year, the deeper the discount. If the stock price goes up substantially, a lot of value could go to the children gift-tax-free." Hall adds, "With careful planning, you can get a lot of leverage on the tax front from the use of a technique like this one. You shouldn't face a current tax bill."
Q: I own stock in other privately held companies besides my own, either through angel investments or strategic partnership deals. Should I think about them any differently, for estate-planning purposes, when I decide whether to wait for changes in the tax law?
A: The answer is yes and no. Follow the same estate-planning strategy that makes sense for the rest of your assets. But with private-equity holdings like these, your heirs could find themselves saddled with all kinds of head- aches and even an estate-tax liability -- regardless of what happens to exclusion amounts. Make sure your estate planner evaluates all relevant documents in advance, including each private company's rules regarding stock transfers in the event of a shareholder's death. Based on your planner's assessment, you may want to set up an irrevocable life-insurance trust to help your heirs handle the likely financial costs.
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For more information, check out this inc.com Guide to Estate Planning.