Reducing Estate Taxes

by Daniel Hiatt

The management of one’s estate includes taking steps to avoid
the federal estate tax. For those dying in 2008, estates in excess
of $2,000,000 are exposed to taxation, increasing to $3,500,000
for those dying in 2009.

 

There are many ways to avoid imposition of the estate tax, such as entering into charitable transfer arrangements or adopting a gifting program during one’s lifetime. Another less obvious strategy is altering the character of what you actually own.

Altering the character of what you own can result in an actual reduction in the value of your assets, rather than the assets themselves. For example, Mr. Jones is a widower. He has three adult children. His estate includes $2 million in cash, plus stock in a Hardware Co., a company which he started in 1971 that is now valued at $4 million. Without any planning, if Mr. Jones dies in 2009, his estate would face a tax liability of approximately $1,800,000.

To reduce his tax exposure, Mr. Jones could transfer all of his stock in Hardware Co., along with perhaps some of his cash, to a new business entity named Continuity, L.P., which would include Mr. Jones, or a company controlled by him, as the general partner, and the children of Mr. Jones as limited partners.

To explain the way a discount can work for Mr. Jones, after transferring his Hardware Co. stock to
Continuity, L.P., the asset includable in his estate would be his ownership interest in Continuity, L.P. Because his interest in Continuity, L.P. is subject to numerous restrictions and conditions, a discount of 25% of the underlying value of Hardware Co. is possible. In large part, the actual discount would depend on a professional appraisal of the interest owned by Mr. Jones in
Continuity, L.P. after taking into account agreements entered between Mr. Jones and his children regarding Continuity, L.P. After applying a discount of 25%, a $4 million asset becomes a $3 million asset resulting in estate tax savings of approximately $500,000.

There is a word of caution regarding this information. To achieve a valuation discount for estate tax purposes, there must be a business purpose in forming the new entity. For Mr. Jones, this was found in having his children indirectly participate in the business life of Hardware Co., including their involvement in the development of Hardware Co.’s succession plan. Specifically, Mr. Jones recognized that in the event of his death or incapacity, that without establishing Continuity, L.P. with his children, Hardware Co. might be thrust into the hands of a stranger-trustee, or a new board of directors, including the children who would be unprepared to know what to do with Hardware Co. Such reasoning of Mr. Jones, commonly referred to as “continuity of management”, is a recognized business purpose.

The fact that there may be hundreds of thousands of dollars in estate tax relief by adopting a family continuity enterprise is the result of a legitimate tax planning initiative. As Judge Learned Hand said many years ago, “Anyone may arrange his affairs so that his taxes shall be as low as possible; he is not bound to choose that pattern which best pays the treasury. There is not even a patriotic duty to increase one’s taxes.”

Disclaimer: This article is for general informational purposes only. It is not intended to, and does not,
constitute legal advice.

 

Danial V. Hiatt is Attorney at Law, Swanson Midgley, LLC.
P     |     816.842.6100
E     |     dhiatt@swansonmidgley.com