Brown & Associates - Attorneys & Counselors at Law, P.L.L.C.

REDUCING THE TAX BITE ON FAMILY OWNED BUSINESSES
(3/25/01)

How can I be sure there will be enough assets to pay estate
taxes and still keep my business in the family for my children?

Last week I told you many of my clients are farmers, ranchers or small business owners who want to leave the business to their children, but don't know how to keep it intact and still pay the estate taxes that come due at their deaths.

I've already addressed one problem my clients face: how to leave the family farm or ranch to the child who is working it while still taking care of the other children.

This week I'll discuss another part of the equation: how to pay estate taxes without mortgaging the farm or destroying the family operation.

Let's continue with the example I used last week. You own a family far, have three children (only one of whom farms with you), and you want your son to continue farming after you're gone.

Should life insurance play a role in my estate plan?

One solution is to use life insurance proceeds to pay the estate taxes. This way, you don't have to hock the farm. Many clients buy life insurance and make it payable to their child or estate so the funds will be available when the IRS or Oklahoma Tax Commission comes calling.

A better solution is to establish a Life Insurance Trust and have the trust pay the taxes after you're gone. Life insurance trusts are relatively easy and inexpensive to establish and guarantee funds will be used for the purpose you intended.

Unfortunately, life insurance isn't cheap and it may not be answer for you.

I can't afford to buy enough insurance to pay the taxes. What now?
Is my family going to be left out in the cold?

Not necessarily. The federal government has long been aware of the predicament of our farmers and ranchers, even before it became a popular topic during the last election. Congress has passed two programs to help farmers and ranchers. Neither, however, is easy to qualify for and few can take advantage of these special benefits.

The first is known as Special Use Valuation and is found in Section 2032A of the Internal Revenue Code. It allows executor to value farm and business property at its "actual use" value, rather than its "highest and best use" value. A classic example is the family orange grove in Orlando, Florida, which was valued as a working grove, rather than as a potential Disney World hotel.

To qualify under Section 2032A, you have to jump through a number of technical hoops. Simply stated, the decedent must be a U.S. resident or citizen; the property must be in the U.S.; it must have been in actual qualified use by the decedent or a family member on the date of death; it must pass to a "qualified" heir; the qualified use must have been for 5 out of 8 years prior to death; and 50% or more of the adjusted value of the gross estate must consist of qualified real estate or qualified personal property and 25% or more of the adjusted value of the gross estate must consist of qualified real estate.

Did you notice all the "qualified" language I cited? These technical requirements are too complicated to discuss in a few paragraphs. If you think you can squeeze your size 12 foot into the Section 2032A size 8 "shoe", check with an estate planning professional who can tell you if you qualify. Often with just a little prior planning and shifting of assets, we can turn a "disqualified estate" into a "qualified estate." But don't wait until you are on your death bed to try to make these changes. It will be too late then to do anything.

The Qualified Family-Owned Business Interest Deduction.

Several years after Section 2032A was passed into law, Congress looked around and saw no one was using it. The legislators realized they had made the hoops too difficult to hop through and came up with a new regulation for farmers, ranchers and business people to use.

The Qualified Family-Owned Business Interest (QFOBI) deduction is found in IRC Section 2057. It permits your heirs to deduct up to $675,000 of the value of a qualified family-owned business and can save you a lot of tax.

To claim the QFOBI deduction, you file Schedule T with your Form 706 Estate Tax Return. Unfortunately, Congress was up to its old tricks again. Section 2057 is just as complex as Section 2032A. You need a trained CPA or estate planning attorney to fill out Schedule T. It asks detailed questions about ownership interests in the family business and the decedent's activities prior to his death. You must prove the decedent met ownership and material participation requirements to claim this deduction.

This isn't an accounting course and I don't want to bore or baffle you with IRS jargon. I just want you to know about Sections 2032A and 2057 so if you qualify, you can save estate tax.

Next week I'll discuss additional techniques to help you keep your business in the family after you're gone.

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