When preparing an estate plan for business owners, it is crucial to consider family dynamics and estate tax exposure in addition to the transfer of control of a business. Legal tools typically included in an estate plan are a last will and testament, revocable trusts, irrevocable trusts, and life insurance policies.
Family & Estate Tax
Family – The business owner’s relationship status dictates how wealth will transfer and to whom. Having a family member, such as a child, directly involved in the business will also inform the estate plan.
Estate Taxes – The business owner’s net worth determines whether he has a taxable estate. Currently, the federal estate tax exemption is approximately $12,000,000 and New York state’s estate tax exemption is approximately $6,100,000. This means that if, at death, the value of your estate is above $12,000,000, estate tax will be due to the federal government.
Below are a few scenarios that illustrate Cuddy & Feder’s approach to estate planning:
- A young single entrepreneur can generally benefit from a will or a revocable trust to direct where property will go at death. A pour-over will works in conjunction with a revocable trust to avoid probate. If the client is just starting out and has an estate valued well below the tax exemption, the concerns will be more family focused. We will help the client prepare documents to benefit loved ones. For a single client with a potentially taxable estate, it is important to use techniques that limit tax exposure but also leave room for flexibility for future life events, such as marriage and children.
- A married client with children and a thriving business will need a different approach to plan for the future of both family and business. For clients who have developed assets above the estate tax exemption amount, an irrevocable trust can be a good tool for minimizing tax exposure. Assets contributed to an irrevocable trust are not counted as part of the taxable estate on death. For example, a business owner might decide to transfer a small portion of stock in a lucrative corporation to an irrevocable trust for the benefit of children. The transferred stock may have a value of only $100,000 when the transfer is made. A gift tax return is filed to report the completed transfer. Ten years later, that transferred stock may be valued at $10,000,000. The $9,900,000 in increased value will benefit the children and is not taxable in the client’s estate. Each client will have a different degree of comfort with the level of gifting to make since these transfers will deprive the client of control over, and the use and enjoyment of, the gifted asset.
- For a client in a second marriage, other techniques can be used to minimize friction while preserving wealth and relationships. For this type of client, a trust structure can help to ensure that hard-earned assets will benefit their own children rather than any relatives of the second spouse. This client may also wish to use a trust to protect assets from being diverted if a surviving spouse remarries.
- In some cases, a business owner may have one adult child who is more involved in business operations than others. In these matters, it is essential to balance financial and tax planning concerns with the importance of leaving a legacy of good relationships among family members and a functioning business to benefit a client’s heirs.
- For high-net worth clients with illiquid business assets, life insurance policies can be useful if there otherwise would be with little cash to cover estate tax obligations. To avoid having to sell the business, or other hard-to-sell or unique estate assets, a life insurance policy held in an irrevocable life insurance trust (ILIT) helps provide liquid funds to cover these obligations. On the decedent’s death, the life insurance policy is cashed out and its proceeds can be used to pay the estate tax. Most importantly, since the trust owns the policy rather than the decedent, the insurance proceeds are not included as part of the taxable estate thereby preventing those proceeds from being taken.
These scenarios do not present all of the complexities of estate planning, but they do provide an introduction to tools we often find useful for clients. Cuddy & Feder’s Trusts & Estates attorneys are here to guide you through the estate planning process from beginning to end.