Estate taxes are taxes due to the federal government upon the death of the owner of a business or estate. At first glance, IRS figures indicate that the tax has a far greater impact on wealthy individuals than on small business owners, but representatives of the latter group insist that it has long been a dreaded levy that packs a deceptive punch among small businesses. They charge that some companies have purposefully stunted their growth in order to avoid ringing up an overwhelming estate tax debt, while others have minimized the impact only through canny—and time-consuming—estate planning. Given such sentiments, recent changes in estate tax law have been warmly received by the nation's small business community. In 2000, federal lawmakers passed a bill that would have phased out the estate tax—nicknamed the "death tax"—over a ten-year period. But President Bill Clinton vetoed the legislation, claiming that the tax affected less than 2 percent of estates, and that eliminating it would have cost $750 billion in tax revenues in the decade after the phase-out.
Federal estate taxes were first established by Congress more than 80 years ago. Since 1976, estate taxes have ranged from 37 percent to 55 percent, depending on the value of the estate, but each citizen had a one-time exemption of $675,000—dubbed the "unified credit"—that may be used against the estate tax or another federal tax known as the gift tax. In 1997, however, this one-time exemption underwent a significant change for the better for small business owners, as the balanced budget deal included a major piece of estate tax relief. Under the agreement, the exemption was increased from $675,000 to $1.3 million, provided the heirs have been involved in operating the business for at least 10 years. "This [change]," commented Janean Chun in Entrepreneur, "will be a relief to family business owners, who may have been limiting their growth to avoid paying estate taxes. It will likely allow family-owned businesses to be passed from one generation to the next, rather than having to be sold to pay inheritance taxes."
Usually, taxes on an estate are due nine months after the death of an individual. However, estates involving closely held businesses have the option of making installment payments instead. These installment payments, which include interest, can be spread out over as long as 14 years, and the first $1 million of the business's value is eligible for a low 4 percent interest rate.
MINIMIZING LIABILITY In addition, small business owners worried about looming estate taxes can take several steps to minimize the impact. "One of the principal steps that companies take in preparing for an expected estate-tax bill is to buy life insurance on the owner or owners," wrote Nation's Business contributor Joan Pryde, "making certain that the policy is owned by the company or a life-insurance trust and that the proceeds are kept out of the owner's taxable estate. Another popular estate-planning technique involves the annual gift giving that is tax-free as long as it doesn't exceed $10,000 per recipient. The gifts can be in the form of stock or other assets."
Pryde points out that businesses can also use tax-exempt charitable bequests of business interests and trusts to minimize estate tax liability. In addition, "transferring ownership of a business through buy-sell agreements, partnerships, trusts, or outright gifts is a key component in many of the planning strategies available to minimize or eliminate estate-tax liability." Business experts caution that taking such steps may be even more important—and also even more complicated—when a small business is owned by two or more family members, since the business can potentially be hit with estate taxes every time one of the owners passes away.
Small business consultants note, however, that establishment of various estate planning initiatives generally involves a fairly significant outlay of cash in and of itself. "You can create trusts, and you can create other vehicles, but they're very costly to administer, and they're very prone to being overturned by the IRS if you don't dot every 'I' and cross every 't,"' an owner of an accounting firm told Pryde. Avoiding the estate tax, said the accountant, "creates wonderful work for accountants and lawyers, but that's not really to the benefit of the small business."
A final option for a small business owner hoping to avoid estate taxes is to sell the business before he or she dies. While such a step brings other tax issues to life, it does provide the owner with cash to pay the estate tax. But as Pryde pointed out, "often the whole point of maintaining a business is to be able to pass it on to the next generation. So selling a business is usually the last resort."
Chun, Janean. "The New Deal." Entrepreneur. October 1997.
"The Estate Tax." Sacramento Business Journal. September 8,2000.
Holtz-Eakin, Douglas. "The Death Tax: Investments, Employment, and Entrepreneurs." Tax Notes. August 2, 1999.
Huddle, Ben T. "Gift-Giving during Lifetime May Prevent Estate Tax Headaches." Business First-Columbus. November 19, 1999.
Pryde, Joan. "The Estate-Tax Toll on Small Firms." Nation's Business. August 1997. "Reform Plans on Congress' Agenda." Nation's Business. August 1997.
Ventry, Dennis J., Jr. "Straight Talk about the 'Death' Tax: Politics, Economics, and Morality." Tax Notes. November 27,2000.