Estate tax law is a political football in which each new administration plays offense or defense depending on their party’s point of view regarding taxes. Under the last administration, America’s farmers and family business owners enjoyed the most favorable tax law since the estate tax was implemented back in 1916. The new administration wants to change that. They want to:
- Reduce the exemption amount from $11.7 to between $3.5 or $5.0 million/person (indexed for inflation).
- Increase the estate tax rate from 40 to 45%.
- Eliminate the step-up in basis.
- Reduce the gift tax limit from $11.7 to $1.0 million/person.
- Increase the Capital Gains tax from 20 to 39.6%.
And, that’s not all. Any one of the above-mentioned changes would be devastating by itself. Put them all together and they become a poisonous concoction that may make continuing family ownership all but impossible.
If these changes happen, farmers and family business owners will need to re-examine their estate plans and prioritize improvements to minimize the damage. Estate planning is never a once-and-done event. It’s a process of continual improvement, which now may be more important than ever.
Estate planning should be part of a comprehensive succession plan. Though similar, an estate plan is designed to minimize the estate tax, pass assets to heirs, and provide support for dependents at the time of an owner’s death.
A succession plan is designed to pass the operation to the next generation as a going concern during the owner’s lifetime. A succession plan will create a smooth ownership transition, provide equitable distributions to the owner’s children—whether active in the business or not, create retirement options for the owner, and mitigate the tax implications.
Done properly a comprehensive succession plan will use estate planning strategies to tax-efficiently pass ownership and other assets to the next generation. It will use estate planning techniques to protect those assets from divorce, creditors, and unscrupulous actors. Using estate planning tools, will protect the integrity of the operation and provide equitable distributions for all of an owner’s loved ones, whether active in the operation or not.
But, planning isn’t easy. Studies show that 70% of first-generation farms or family businesses will not transition to a second. Of those that do, 90% will fail in the transition to a third. And, of the few remaining after that, 96% won’t make it to a fourth.
When it comes to planning, most owners are confused and befuddled by the process. They’d rather go to work than talk about what might happen if… They tend to focus on the here-and-now, relying on their trusted advisors to suggest planning needs and tax improvement strategies.
But most advisors are ill-equipped and uncomfortable facilitating the succession planning process. Far more than legal documents and life insurance policies, a comprehensive plan requires a professional who is well-versed in legal, tax, and financial disciplines. That professional must be comfortable in a counseling role, working with multiple owners, various family members, and a team of specialists. He/she must be focused on helping an owner achieve financial security, create a smooth ownership transition, establish a management structure, and design a tax-efficient estate plan. Succession should be a natural next step for a growing-concern.
I’ll be happy to clarify concepts and answer your questions about succession planning in future columns. Write to me at Kevin@Legacy-by-Design.com. Let me know how I can help. Whether it’s a question like, What triggering events should be included in a buy-sell?, How do I protect my farm from being included in a divorce settlement? Or, When should I talk to dad about succession? I’ll be happy to share my experience.
Kevin Spafford, CFP®, helps farming professionals and family business owners plan for succession. Legacy-by-Design.com has numerous planning resources. Kevin is available at 530-671-2100 or Kevin@Legacy-by-Design.com.