Protecting Your Business and Family Wealth: Lifetime Strategies
Procrastination. That's what many successful business owners do, instead of effectively planning
for the future. Now that they have accumulated sizable wealth, they become immobilized by
seemingly conflicting concerns: how to retain control of their assets as they approach retirement
age, retain enough income to live on after retirement, minimize their children's estate taxes, and
provide for their families' security after they die. Mixed into the equation may be a desire to
eventually pass on the business to the next generation.
These goals need not be at odds with each other, however. There are ways to maintain control of
the family business or other assets and generate an income stream, while keeping a lid on your
estate tax bill. You may want to consider some of the following strategies as you map out your
Small business owners can shift ownership to other family members and reduce
the size of their taxable estate by transferring to them gifts of stock in the business. The savings
on estate taxes could be substantial. For 2004, the federal estate tax rate for the "first dollar over
$1,500,000" is 45 percent. On amounts over $2,000,000, the rate is 48 percent.
Gifts of stock directly to your children fall within the $11,000 ($22,000 per couple) annual
exclusion rule. You and your spouse can transfer $22,000 of assets each year to each child. For
example, a total of $44,000 can be transferred to two children, for a total of $44,000, without
paying federal gift taxes or eating into the lifetime exemption. Further, as a closely held business,
you may be able to take certain valuation discounts - and save on transfer taxes - when making
gifts of minority interests in your company. The discount is a recognition that a minority interest
may be worth less because of the lack of control and marketability inherent in minority
So, for instance, you might give away a small stake in your family business to your daughters
each year and discount those shares by 30%. That means you could give them a stake with a face
value of $15,715 per year, discount it 30%, and still remain under the $11,000 annual exclusion
limit. Remember too, making this gift of stock removes the value of the gift and all its future
appreciation from your estate. Thus, a $11,000 share in the business you give away today might
grow to $100,000 in twenty years, a substantial increase that escapes future estate taxes at your
Family Limited Partnership.
Estate leveraging, discounting and reduction strategies can also be
accomplished with Family Limited Partnerships (FLPs). An FLP is a limited partnership that
consists of family members, usually parents and their children or trusts for their benefit.
Typically, the parents contribute business and investment assets to the trust in exchange for a
general partnership interest, and the younger generation is gifted limited partnership interests.
The general partners are liable for the partnership's obligations, while limited partners only have
their capital contribution at risk and do not participate in the control or management of the
FLPs allow senior family members to retain control of the assets that are placed in the
partnership, but yet transfer more than a minority interest through gifts of limited partnership
interests. For instance, when creating a FLP, you might give away 98% of the business to seven
family members, while a general partner holds a 2% interest. The general partner maintains
control of the business, while the transfer of the limited partnership interests gets a large portion
of your business? value out of your estate that will potentially reduce federal estate taxes. By
transferring limited partnership interests in the business to your children over time, you may
utilize your annual gift tax exclusion. Gifts of interests in FLPs are also popular because they can
utilize discounts for lack of marketability and control.
The partnership can be structured so that you can shift income among family members, while you
and your spouse continue to receive income in the form of salary.
Qualified Personal Residence Trust.
For those with significant assets, another way to reduce
federal estate taxes is with a Qualified Personal Residence Trust (QPRT). These trusts allow
homeowners to give a principal residence or vacation home as a gift to a trust established for a
specific term. Legally speaking, the homeowner transfers a remainder interest in the house and
continues to live there for a set number of years.
Suppose you want to pass on your home, currently worth $500,000, to your children. You also
plan to retire in ten years at age 70 and move out of state. Rather than give them the house when
you retire and incurring hefty gift taxes on its appreciated value, you can, in effect, give it to
By placing your home into a QPRT, you may be able to remove it from your estate -- thereby
avoiding future estate taxation. You live in the house during the ten years, then ownership passes
to your children. Since your kids must wait a decade to receive the property, the IRS discounts
the value of the gift they are getting. Thus, the house would be considered a gift of approximately
$282,000 (the present value of $500,000 using a 4% applicable federal rate). If the house
appreciates during the decade, the trust will produce bigger savings since it freezes the value of
the children's interest at $282,000. These trusts have their drawbacks, however. If you die before
the trust expires, the house is kicked back into your taxable estate at its full date-of-death value.
If you move or sell the house before the end of the trust term, you may also lose the tax
advantages if the house is not replaced within certain time constraints.
Grantor Retained Annuity Trust.
Another kind of estate planning tool, known as the Grantor
Retained Annuity Trust or GRAT, lets you remove assets from your estate without giving up the
income they generate. GRATs can be effectively used for the transfer of closely-held business
interests. Using this trust, you can potentially remove an asset from your estate with reduced gift
tax consequences, as well as enjoy annuity income from the asset transferred to the trust for a
predetermined period of time. Family-member GRAT beneficiaries ultimately receive the gifted
assets -- whether stock, investments, or real estate -- at the end of the trust term.
Since they are annuities, GRATs pay you a fixed dollar amount each year. For instance, the trust
could pay you $4,000 annually. Be cautious, however. If you take more income from the trust
than you can use during your lifetime, you will wind up putting that unspent money back into
your taxable estate and possibly paying estate taxes on it. Your gift tax is based on the present
value of the remainder interest going to your heirs. Therefore, you will be transferring the assets
at a discounted rate. That means a lower gift tax bill for you. Since GRATs are irrevocable, you
can't take the assets back later if you decide you need them. So be sure you can afford to lose
control of those assets before placing them in the trust.
Used correctly, these various techniques may help you meet your goals of reducing the size of
your taxable estate, retaining income, keeping control of your assets, and passing on your
business to your heirs when you retire. Contact an estate planning professional to get a better
idea of how you can protect your family's assets as they continue to grow.
Eric C. Weiss is a registered representative of Lincoln Financial Advisors, a
broker/dealer, and offers investment advisory service through Sagemark Consulting, a division of
Lincoln Financial Advisors Corp., a registered investment advisor.
This information should not be construed as legal or tax advice. You may want to consult a
tax advisor regarding this information as it relates to your personal circumstances.