Business owners can save a ton of estate taxes by kicking the bucket this year rather than next. But there are less drastic solutions.
Gridlock in Washington has its upsides, but tax simplification is not one of them. This year, once again, a number of big tax breaks expire with no certainty about what comes next. That means there are a number of smart tax moves you may want to consider before 2012 ends. One of them is to die.
Congress, in its wisdom, gave each person a $5,120,000 exemption from estate and gift taxes this year, up from $5 million in 2011. That's good for business owners! Unfortunately, this generous break lasts only until January 1, 2013. Thereafter, if Congress does nothing, the exemption retreats to $1 million, a level last seen in 2003. That's bad for owners. A low exemption poses a problem to anyone transferring business interests to future generations.
Now, let’s take a closer look at the estate tax. It is a “second-layer tax” levied at death on the value of assets built up in life. Remember that you've paid income tax in order to create those assets. If your estate happens to be larger than the exemption, you then have the privilege of paying an additional tax at death.
Since the levy generates very little revenue for the US– around 1% of total tax receipts – it is immaterial to the United States’ financial well-being. Its real value appears to be as a political football to members of congress who wish to debate how the country’s tax burden should be spread.
Be that as it may, the estate tax exemption is here (it also applies to gifts you give while alive), and you might as well take advantage. One way, obviously, would be to die this year and qualify for the whole $5.1 million exemption before it reverts to a mere million in 2013. From a tax planning point of view, that would be a home run. The only problem is, you never come up to bat again.
A less drastic strategy would be to get shares of your business out of your name this year by making gifts or creating trusts. Here are some things to consider:
You can give gifts of voting or nonvoting stock to family members. Gifts you give this year above $13,000 ($26,000 if given jointly with your spouse) eat into your estate exemption. But better to eat into it when it's $5.1 million, than when it might be as little as $1 million. And if you reduce your ownership interest below 51%, that stake may be valued at a discount at death, which further lowers the estate tax.
You can set up a lifetime credit trust to reduce your taxable estate. Traditionally, this type of trust is formed when you die, but it doesn't have to be. It can be set up to provide benefits to your spouse and children, and why shouldn't they start to benefit while you're alive? As with the gifting strategy above, you'd have to use some of your estate-and-gift exemption to transfer shares to your trust. But you will use the exemption eventually anyway – right? Why not take advantage while there's $5.1 million to take?
In short, Congress's gridlock has provided both the opportunity and the motivation for aggressive planning this year. Some call such opportunities “loopholes;” I prefer to think of as them as prudent strategies supported by congressional policy. Whatever you call them, though, remember the famous words of Senator Russell B. Long: A tax loophole is "something that benefits the other guy. If it benefits you, it is tax reform."
Michael Foltz, JD, CPA, CFP contributed to this article
MARK BALASA, CPA, CFP is Co-Chief Executive Officer and Chief Investment Officer of Balasa Dinverno Foltz LLC. Mark has been named seven times as one of the “Best Financial Advisors” in the U.S. by Robb Report Worth magazine.