Changes in Planning for Closely Held Businesses Under the New Tax Law

by Saul Ewing Arnstein & Lehr LLP

The tax changes recently signed into law increased the exemption from federal estate and gift taxes to about twice the prior level. Even though the increase is temporary and will expire at the end of 2025, it changes some of the opportunities for planning by the owners of closely held and family businesses.

For many years, planners focused on the goal of minimizing estate taxes on the transfer of family-held businesses. This was thought to be the greatest danger in accomplishing a transfer of ownership to the next generation. A solution frequently used was the gift, directly or through trusts, of stock ownership during the owner's life, taking advantage of the annual exclusion for gifts ($15,000 per donor per donee in 2018) and the ability to apply discounts to gifts of minority interests in closely held businesses. This technique was used so frequently that the Treasury Department proposed regulations to curtail the practice; regulations that were withdrawn by the new Administration in Washington. By techniques of this type and others, it was possible for most families to avoid estate tax liability on transfers of business interests. The idea that estate taxes caused forced sales of businesses wasn't borne out by actual experience, except in those cases where owners didn't bother to plan.

But there was one downside to this type of planning, and it involved income taxes rather than estate taxes. When ownership of a business was transferred during life, the recipient of the ownership took the same basis as the previous owner had. So if the owner started the business, he or she might have a very low tax basis in the business.  If the new owners decided after some time to sell the business, they could face a huge tax bill from the capital gains on the sale.  First prize would have been to avoid estate taxes and the tax on capital gains.

As a result of the new tax law, many businesses wil now be eligible for "first prize". The much increased federal estate tax exemption, probably more than $22,000,000 for a married couple, means that many businesses will never face a federal estate tax; and this means that planning can be done to minimize taxes on the eventual sale.

The method of doing this is to ensure that the business assets remain in the original owner's estate at death, which steps up the basis of the business ownership to its value at the date of the owner's death. Sounds easy, but there is some planning that needs to be done. Business owners need to consider the importance of assuring the next generation that it will receive the business interests; that the next generation will not be left wondering whether they will in fact inherit the business. And there are ways to provide that assurance.

In addition, planning has to take into account the possibility that the increased exemption will disappear at some point, at the end of 2025 or maybe earlier. What this means is that every solution will not be the same. Business owners need to sit down with their advisors now and in the next few years to discuss what they want to accomplish, not just with their business assets but with all of their assets, and prepare a plan that navigates the tax and non-tax goals and problems. the reward for doing so, as a result of the much enhanced federal estate tax exemption, can be significant savings on a multi-generational basis.


DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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