Estate Tax, Inheritance Tax, and Their Roles in Family Business Succession

Posting by Geoffrey D. Brown, CPA

Whether called an estate tax, an inheritance tax, or the earthier “death tax,” the taxes imposed upon the estate left behind after a family business owner passes can be a most unwelcome, untimely, and unplanned for surprise. As we so often advise family businesses, ignoring the mortality of the owner by not planning how the business will carry on after his or her exit – be it voluntarily through retirement, or perhaps by an unexpected death – can only spell further distress to those remaining in the family business. Succession planning is seldom discussed without the related estate planning, as how the estate taxes will be handled is indeed one of the functions of the succession plan.

Who is paying what taxes when? It can be confusing. There is the estate tax, which is based on the value of the deceased person’s estate and on when they died (and not on who gets what); and the inheritance tax, which is based on who receives a deceased person’s property, and how the beneficiary is related to the deceased person. Then different states have different laws (not all states even have an inheritance tax), and the laws are always subject to change, and in some cases one tax can supersede the other. It doesn’t seem fair to work so hard building your family business, only to have it wiped away by taxes after your passing. However, this happens, and families find themselves unprepared to handle the tax bills, and unaware that the taxes could have been avoided or reduced by careful planning.

Succession plans aren’t just for planned retirement. Ideally, family business owners – and everyone for that matter – would rather die according to a plan and schedule, or not die at all. Of course this is unrealistic, but succession plans are put off for decades or forever with this hope in mind. Although it may be unpleasant to think about the unthinkable regarding our loved ones and the family business, isn’t it more distasteful to name the IRS as your primary beneficiary upon your passing? Unfortunately, that is what may happen when there is no succession plan in place, and no connection to an estate plan.

How do these taxes fit into the succession plan? The succession plan names who the family business passes on to after the owner leaves the business – in the case of death, this succession now also involves possible taxes on the estate itself (money, other assets, the business, etc.), and for a successful family business this can be quite substantial – especially when the value of the estate exceeds the current exemption. For example, there could be a manufacturing facility and machinery owned by the business, and that value is now part of the estate so any exemption may not be enough. Paying the 40% federal estate tax on an additional $10 million value of the business could bankrupt the company, or at a minimum make the immediate payment required possible if the money is tied up in these difficult-to-sell assets. Planning for the easier liquidation of assets to cover required estate taxes can be a lifesaver also.

No one has been named as successor? The spouse or child may get the business by default, but here’s the issue – the spouse likely won’t have to pay the inheritance tax yet (the debt will just get passed on after the spouse dies), but in many cases the child will still be paying the inheritance tax. So in addition to the sad passing of the owner, there could be infighting among family members over who gets what, and pressing money problems on hand. Imagine how upset they will become when they discover that an estate plan could have put assets in a better position with tools such as trusts and gifting to reduce the impact of taxes, and possibly save the company from implosion.

Responsibility starts at the top. A family business is so much more than just a business – it is typically founded with a vision, and a desire to keep the business giving to the family and the family giving to the business long after the founder is gone. This visionary owner is ultimately to blame if there is no plan to protect the family and the business once the business moves to the next generation. And there are few cases where the management of money and expenses isn’t right at the top of family business concerns. Planning for all aspects of succession now can be your best defense against these taxes.

Due to the complex and changing nature of estate and inheritance taxes, and varying laws from state to state where business is done, it is strongly recommended for family businesses to ensure their concerns are covered by discussing their wishes with qualified financial planning specialists, estate planning attorneys and other outside consultants who have handled hundreds of succession plans. Periodic reviews of the succession plan take changes in estate laws, wishes of the business owner and other circumstances into account, thus minimizing the impact of taxes on the family and the business.

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