Estate planning, more an art than a science, is best explored when business owners and their companies are young and their options for reducing estate taxes are the greatest. Too many entrepreneurs postpone or ignore the process, leaving their companies and their families financially vulnerable in the event of their untimely death.
Randall Jamail, founder and chief executive of Justice Records, in Houston, is a notable exception. Jamail, age 37, embarked on the estate-planning process before his seven-year-old capital-intensive growth company reached $2 million in profitable sales.
"We very much see ourselves entering Phase II of our business development. We've built an incredible infrastructure and can now push the company to faster and ever more profitable growth," Jamail says. "So it's been clear to me for a while that if I wanted to minimize the tax consequences of estate planning, I would have to act quickly, before the IRS decided our company was too valuable."
Here's the plan Jamail evolved: to avoid gift or estate taxes, he proposed to transfer minority stakes in Justice Records' stock to his three children before the company showed a profit. In the eyes of the IRS, such stock is valueless and thus the transaction is basically a tax-free one. That's an ideal strategy for the owners of growth companies. But often owners are so preoccupied with building their businesses that they fail to recognize the price of acting too late -- when their profitable companies have incurred tax liabilities.
Jamail originally approached his corporate lawyer and his accountant with his plan a couple of years ago. They said, he recalls, "that I was better off waiting awhile before acting." The reason? As the owner of an S corporation, Jamail was entitled to use Justice's tax losses to offset other forms of his personal income. "I could have transferred minority stock stakes to my children back then, but those tax losses wouldn't have had any value for them, and they certainly did for me."
The chief executive and his advisers set a modified course. Jamail would carefully monitor his company's progress to anticipate the year in which Justice would achieve profitability. Then he'd give stock to the children just before the IRS could assess its taxable value. "That's guesswork, and you've got to accept that you'll always act a little early or a little late," Jamail says.
Still, the CEO achieved his goal of transferring a 15% stake to each of his children -- then 17, 4, and 2 -- while the stock's value was still within the IRS's annual limit that allows $10,000 worth of tax-free gifts per recipient. Expecting his fourth child this month, Jamail notes, "I plan to transfer stock to the new baby, too, but the company is now growing so fast and so profitably that we'll probably have to figure out a new strategy to minimize tax consequences."