Estate Tax Planning and Filings

The largest asset belonging to most business owners is their business. This fact is important to heirs and the estate planning process, particularly if the value of the business creates a taxable estate above federal and state exemptions.

If a business owner has the desire to create equality among his or her heirs – between a spouse and surviving children some of whom may have been actively involved in the business – it is much easier to accomplish parity when the value of the business is set. Simple mathematics can be used to divide the assets. Often, though, if the goal is to keep the business intact for the next generation to manage, the business’s real estate can be used to create a balance of distributions, leaving control of the operating asset for the benefit of those interested in managing it.  Knowing the value both of the operating business and the real estate can help the executors determine which other assets might be given to family members to reduce the size of the taxable estate.

Planning ahead to avoid estate taxes while the owner is alive may motivate the owner to assign  marketable investments, real estate, collectibles, etc., to certain family members not involved in the business, retaining interest in the business for those heirs who will operate it in the future.  If the plan is for the business to remain in the family, gifting a portion of the business while the owner is alive might also be an appropriate course of action.

As of the date of this writing (2016), the estate and gift tax exemption is $5.45 million per individual, meaning an individual can leave $5.45 million to heirs and pay no federal estate or gift tax. A married couple exemption is $10.9 million. The tax rate on the excess value of an estate is 40%. The annual gift exclusion is $14,000. State estate taxes are often at a much lower threshold.

The Portability of Estate Tax Exemption rules provide for the transfer of a deceased spouse’s unused estate tax exemption (“Deceased Spousal Unused Exclusion Amount” or “DSUEA”) to a surviving spouse (without inflation adjustments). Thus, if a 2015 decedent’s taxable estate is not more than $5,430,000, the DSUEA can be used by the surviving spouse with respect to both gift taxes and estate taxes (but not GST taxes). Portability is not available if either spouse is a nonresident alien. Portability may allow some couples to forgo a more complex estate plan while still taking advantage of both spouses’ transfer tax exemptions. Portability must be irrevocably elected on a timely filed (including extensions) estate tax return, even if a return is not otherwise required to be filed.

A typical estate plan for a married couple often provides for the establishment of several trusts at the death of the first spouse, one of which is an “Exemption (or “Bypass” or “Credit Shelter”) Trust.” One of the reasons for the Exemption Trust is to use the deceased spouse’s estate tax exemption to the fullest extent possible. Under the portability law, however, if one spouse dies and leaves assets to persons (other than the surviving spouse and charity) in an aggregate amount less than the basic exclusion amount ($5,430,000 in 2015), the surviving spouse may be able to use the DSUEA as well as the surviving spouse’s own exemption.