Times Favorable To Pass the Bucks

Wealth transference could be the silver lining in today’s overcast economy.  

Many financial experts say now, when values are depressed and tax rates are comparatively low, may be the best time for high-net-worth individuals to begin transferring wealth to their heirs.

Now is probably the best time to transfer assets of the family business, said Keith Ekenseair, a managing partner with Frost PLLC.

In the current economic conditions, many companies are not performing as well as they have been, so business valuations are down.

“Theoretically, today’s valuations are less than they were a couple of years ago,” Ekenseair said. “Certainly for people who believe their company is going to be stronger in better economic times, now is clearly one of the best opportunities to create a wealth transfer.”

Wealth transfer planning is a way for individuals to move assets during their lifetime, maximizing their bequests to their heirs by minimizing the estate tax imposed at the time of death.

Under the current tax law, estates that exceed $3.5 million for an individual and $7 million for a couple are subject to a tax at a rate of 45 percent.

With no action by the U.S. Congress, the controversial estate tax is slated to disappear in 2010 and return in 2011 with an exemption of $1 million for an individual and a tax rate of 55 percent.

But experts say 2010 is not likely to be a tax-free year.

Ekenseair said the expectation is that Congress will pass a new law before the year’s end.

“It’s very likely that something will change,” he said.

Ben Shaddox, a certified financial planner and a principal in Legacy Capital Group, said there certainly won’t be any softening in the estate tax laws.

“With the new administration, it’s not going to go anywhere but north,” he said.

President Obama’s budget proposal calls for keeping the estate tax at its current levels of 45 percent on amounts above $3.5 million for individuals and $7 million for couples.

But regardless of what happens in Washington D.C., accountants and financial planners said lifetime estate planning is critical in protecting beneficiaries from having to use a large chunk of their inheritance to pay the estate tax bill.

Gifting
One way to minimize the estate tax is to transfer wealth through gifting.

By gifting assets to heirs over their lifetime, a person or married couple can reduce the value of their taxable estate, thus reducing the amount that can be claimed by the government upon their death.

As the federal tax law currently stands, a person can give up to $13,000 per year without getting hit with the gift tax.

A married couple can give up to $26,000 per year without any tax consequences.

Individuals also have a tax credit that allows them to give up to $1 million over their lifetime without incurring taxes. The credit doubles for married couples.

Shaddox said it’s more advantageous right now to transfer assets as gifts because values are depressed. That means the annual gift tax exclusion goes further.

For example, if the family business stock was worth $50 per share in 2008 and is now worth $20 per share, more shares can be gifted without triggering the transfer tax.

When those shares go up, he said, the value appreciates outside of the estate.

John Ervin, owner and CEO of Ervin & Co. said gifting business interests to a family member is often accomplished through a family limited partnership.

Through a family limited partnership, parents can begin to shift their wealth to their children and still retain control of their assets by giving the children a minority interest.

When a minority interest, or non-controlling interest, is transferred to an heir, certain discounts apply.

While discounts vary by situation, they generally range from 25 percent to 35 percent.

For example, if a company is worth $1 million and 30 percent ownership is transferred to the heir, that interest would be worth $300,000. But because the heir has no decision making power, a discount is applied.

Assuming a 30 percent interest applies, the value of the transfer would be reduced to $210,000.

Ervin said this wealth transfer strategy has worked well for his clients who operate family businesses and want to transition ownership from one generation to the next.

The second generation gradually becomes more in control of the overall operation while parents reduce their estate tax.

Life Insurance
For individuals planning to leave the family business to their heirs, financial advisers said life insurance can be used to protect the business.

A business owner can purchase a policy that will cover the taxes on their estate, so their heirs won’t be faced with selling off the business’ assets to pay the taxes.

Shaddox said he’s seen cases where the heirs were forced to liquidate the business assets at fire sale prices in order to pay the estate tax bill, which is due nine months after the event of death.

“People have an adverse taste in their mouth when it comes to life insurance, but if done properly, it can be an extremely valuable wealth replacement tool,” he said.

Life insurance is also helpful when the business involves partners, Shaddox said.

In the event that one owner dies the other owner can use the proceeds from the life insurance policy to purchase the business interests from the spouse or heirs of the deceased owner.

Trusts
Some financial advisers encourage establishing a charitable trust as a way to preserve wealth.

Individuals can transfer assets, such as stock or real estate, to a charitable trust. This allows them to defer or even avoid capital gains taxes on the sale of the assets.

The sale of land can then provide an income stream.

For example, Shaddox said, if a person owns a piece of land along Interstate 540 and they decide to sell the land, they’re going to pay 20 percent to 30 percent in capital gains tax.

If they draw up a charitable trust and sell the land under the umbrella of the trust, the trust then kicks off 5 to 6 percent income every year. When the person dies, what’s left over will go to the charitable organization.

Trusts can also be helpful in avoiding probate, Shaddox said.

Since probate only affects assets a person owns at the time of their death, that individual can avoid probate by transferring assets out of their name and into a revocable trust.

There are several dynamics involved in estate planning, Shaddox said, and as tax laws change, it can be a moving target.

That’s why it’s important for individuals or families with significant wealth to have a financial planner, an accountant and a tax attorney, he said.

There are many ways to transfer wealth, Ekenseair agreed, and each person’s plan must be designed to fit their individual needs.

 “There’s not a one fits all rule for everyone,” he said. “Everyone needs their own plan to meet their personal and family goals.”

The Estate Debate
The estate tax has been part of the federal tax code since 1916 and the subject of heated debate for nearly as long.

When President George W. Bush signed the Economic Growth and Recovery Act of 2001, sweeping changes were made to the estate tax. The estate tax exclusion, which was $675,000 in 2001, increased by steps each year, to $3.5 million in 2009, with a repeal of the tax scheduled for 2010.

Because the act is subject to a sunset provision, the estate tax will disappear for a year before being reinstated in 2011, unless Congress acts before then.

That means the controversial tax is yet again up for debate.  

A proposal by President Barack Obama would leave the estate tax at its current levels, affecting estates worth more than $3.5 million for individuals and $7 million for couples.

According to an analysis by the Tax Policy Center, that means 99.75 percent of deaths would not trigger the estate tax.

Yet efforts to repeal or reduce the tax continue in Washington.

Sen. Blanche Lincoln sponsored a budget amendment on April 1 that would have raised the exemption to $5 million per individual and $10 million per couple. The proposal would have reduced the tax rate from 45 percent to 35 percent.

Lincoln’s proposal passed the Senate with 51 votes, including Sen. Mark Pryor.

The tax cut was later dropped in House and Senate budget negotiations but the debate is not expected to end any time soon.

In order to avoid a repeal in 2010, estate tax reform is anticipated by the end of the year.