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Fall 2004 |
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INFOLETTER
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Partner's Perspective |
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Estate Planning Strategies in Light of Tax Legislation
By James M. Bowen, CPA, MT, Tax Partner
With the passage of the Economic Growth and Tax Relief Reconciliation Act of
2001 (EGTRRA) almost three years ago, estate and business succession planning
entered a new phase. There is much good news in the 2001 tax relief act, but the
bad news is that it made estate and succession planning much more complex and
uncertain.
The Good News
First, the good news: EGTRRA reduces the top estate and gift tax rates as
follows:
Year
2004
2005
2006
2007-2009
2010 |
Maximum Rate
48%
47%
46%
45%
0% |
As you can see, the estate tax is fully repealed in 2010. In addition, the
estate tax exemption (or "applicable exclusion amount") is increased,
rising to $1.5 million this year, $2 million in 2006 and $3.5 million in 2009.
(The lifetime gift tax exemption remains $1 million.) This allows individuals to
leave significantly larger portions of their estates to their heirs free from
estate taxes.
The Bad News
The bad news is that in 2011, not only does the estate tax reappear, but it
reappears at the pre-EGTRRA top rate of 55%, and the exemption falls all the way
back down to $1 million. This creates the bizarre scenario in which an
individual could die on December 31, 2010 and his heirs would pay no estate tax
- but if he lived one more day and died on January 1, 2011, his heirs could owe
as much as 55% of his estate in taxes!
The reason that EGTRRA was created with this type of "sunset"
provision was so that the total numbers in the entire tax package would be
politically palatable. Permanent repeal of the estate tax beyond 2010 is a
hot-button political issue: the current administration favors permanent repeal,
but mounting budget deficits make it far from a sure thing. While few expect us
to make it all the way to 2011 without some kind of more permanent
"fix," what this fix will be is anyone's guess.
What You Can Do
Given all this uncertainty, what's the best course of action to take with
regard to estate and succession planning? The first step is a careful review of
your current estate plan with your attorney and accounting professional. If you
haven't re-examined your plan in light of EGTRRA, do so immediately, because
portions of it likely will need to be changed.
For example, many plans fund trusts with assets equal to the estate tax
exemption amount. But with this amount increasing significantly between now and
2009, this approach may result in a larger percentage of your estate going into
trusts for your children than you intend. In this same scenario, the increase in
the estate tax exemption may also result in your spouse receiving less than you
intend upon your death. One possible solution is to cap the total amount of
assets passing to children at a certain dollar amount or percentage of assets.
Here Are Some Other Strategies To Consider:
Check title to assets. You want to make sure that both spouses have
enough assets titled in their names to take full advantage of the increased
exemption amount. For this year and next, each spouse may shelter up to $1.5
million in assets from estate taxes, or a total of $3 million jointly. However,
if they have combined assets of $3 million and $2 million is titled to the
husband
(and only $1 million to the spouse), then they can only shelter $2.5 million,
because the husband's maximum exemption is $1.5 million (plus the spouse's $1
million equals $2.5 million).
Make annual exclusion gifts. In addition to the $1 million lifetime
gift tax exemption, you and your spouse can also each give up to $11,000 a year
($22,000 combined) to an unlimited number of individuals free of gift tax. A
couple with three children could give away up to $66,000 a year, or more than
$1.3 million during 20 years, via this strategy. It might even make sense to eat
into your $1 million lifetime gift tax exemption by giving away more than
$11,000 a year, because this will remove any future appreciation or income
generated on these assets from your taxable estate and, thus, lower your
ultimate estate tax bill.
Establish a Family Limited Partnership (FLP). FLPs allow you to
transfer indirect ownership of your assets (typically to your children) by
gifting limited partnership interests to them, rather than the actual assets
themselves. Inherent in this indirect ownership are lack of control and/or lack
of marketability discounts, which reduce the value of the assets owned by your
children at your death, thus reducing estate taxes as well. (See boxed article
for more on FLPs.)
Pay your heirs' medical and educational expenses. Certain amounts paid
directly to qualifying educational institutions or medical providers are free of
gift taxes. This exclusion is in addition to the annual $11,000 gift tax
exemption and includes health insurance premiums and tuition payments for
nursery school through graduate school.
Call in the Professionals
The added complexity and uncertainty brought about by EGTRRA make it more
important than ever to work closely with your professional advisors when it
comes to estate and succession planning. Doing so can save your heirs big money
- and headaches - down the road. If you would like to discuss your plans, please
don't hesitate to call or email me at jimb@bobermarkey.com,
or your Partner/Manager contact at Bober, Markey, Fedorovich & Company, any
time. BMF&C
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The IRS Speaks Out On FLPs – At Last
Family limited partnerships (FLPs) have never had many fans
at the IRS, at least not when they’re used as an estate planning
tool to discount the value of assets. Over the years, the IRS
has attacked FLPs from many directions. In fact, its initial
stance was that they could not be used for this purpose,
although the agency lost the cases in which it argued this.
Early last year, the IRS finally announced the discounts that
it might be willing to allow in FLP cases. FLPs established
immediately before death would be allowed no discount, while
those established earlier and consisting of public stocks and
bonds would be allowed discounts in the range of 10-20%. For
FLPs consisting of active business assets (such as rental real
estate), the discount would be in the 30-40% range.
The IRS noted that the size of the discount negotiated would
likely vary from one area of the country to the next. But if
discount disputes reach the National Office, these are the
ranges that taxpayers can reasonably expect the IRS to accept.
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Is Your Compensation and Benefits Package Up to Snuff?
By Dale A. Ruther, CPA, CIT, Partner
 It's
one of the biggest challenges for most small business owners: creating a
compensation and benefits package that can compete with the ones offered
by larger firms, which usually have much bigger budgets for employee
perks and benefits.
Few would argue with the fact that a competitive compensation and benefits
package is a necessity if you want to hire the best and brightest employees in
your industry. But while you obviously need to pay well, you don't necessarily
have to overpay to attract the best employees - especially if your office is
considered a better-than-average place to work. Here are a few guidelines with
regard to salary and benefits:
- Find out where you stand. A wage survey of your community will tell you
what others are paying for similar job titles, as well as the benefits they
are offering. Employment and temp agencies are often a good source for this
information. For a truer picture, compare like jobs within your immediate
driving area, as wages can vary widely by locality.
- Set salaries accordingly. A good rule of thumb is to aim for the 75th to
90th percentile. In other words, your staff will be paid more than 75 to 90
percent of the workers in your community doing the same job.
- Offer low-cost perks. You don't have to spend big bucks on perks and
benefits to make a big impact. Consider these low-cost but highly valued
perks:
- Memberships in professional or trade associations - many employees want
to get involved in industry trade associations in order to meet their
peers and broaden their professional horizons. Your company will benefit,
too, from the knowledge they'll gain and put to work in your business.
- Warehouse club memberships - Family memberships at warehouse clubs like
Sam's Club or Costco only cost about $35 a year and will likely be viewed
as an extremely valuable perk by employees, because it will make their
paychecks go farther.
- Movie tickets and restaurant coupons - Keep a stash in your drawer and
give them away spontaneously when you see employees doing an especially
good job or going above and beyond the call of duty.
Finally, never underestimate the power of the little things, like a heartfelt
"thank you" or pat on the back for a job well done. Let employees know
early and often that they're a valued and respected part of your business.
Please call or email me at dale@bobermarkey.com
if I can help with other ideas. BMF&C
Succession Planning: Equal vs. Fair
By Cindy S. Johnson, CPA, Partner
 One
of the greatest challenges to a family business is the treatment of
family members who aren't actively involved in management. Like so many
issues faced by family businesses, meeting this challenge requires an
analysis of both business and family concerns.
Parents want to treat their children fairly, and the natural inclination is
to conclude that fair means "equal." But when a business is involved,
this may not hold true. Consider the following example.
Example 1
John is the founder of ABC Inc. He has three children: Adam, who works in the
business, and Beth and Carl, who have pursued other interests. Most of John's
net worth is tied up in the business. In his estate plan, John allocates the
company's stock equally among his children.
Adam feels this arrangement is unfair because (1) it gives control to the
siblings who aren't active in the business, and (2) it fails to recognize and
reward his contribution to the company's value.
Beth and Carl may also feel short-changed. Unlike Adam, they don't earn
salaries from ABC. Unless the company pays substantial dividends, Beth and
Carl's interests may be of little value to them unless the business is sold.
With control of the company, Beth and Carl could force a sale, but that may
leave Adam without a job.
On the other hand, would it be fair for Adam to receive the bulk of John's
estate simply because he chose to work in the family business?
Planning is the Key
The solution to this problem is different for each family business. It
depends on a number of factors, including the ability of the business to
generate income, the value of non-business assets in the founder's estate, and
the needs of individual family members.
The key is to begin planning early - during the founder's lifetime. Failure
to address and plan for these issues can lead to dissatisfaction and resentment
that threatens both the family and the business.
By identifying the needs of each family member - in and out of the business -
and designing a plan that satisfies those needs, everyone involved should
perceive the plan as fair.
The following example outlines a different plan that worked for the family,
better than equal stock allocation to the three children.
Example 2
John (from Example 1), his wife Mary, and their three children meet with an
advisor to discuss their plans. John's main objectives are to retain control of
the business until Adam is ready to take over, to provide income for Beth and
Carl, and to minimize estate taxes. Adam's main objective is to assure that he
will gain control of the business in the future. And Beth and Carl want to make
sure they receive a fair inheritance.
Here's the solution they devise:
- John re-classifies his stock in ABC (an S corporation) into voting and
nonvoting shares. He retains 25 percent of the company's stock with 100
percent of the voting rights.
- John gives 45 percent of the stock to Adam. By taking advantage of
valuation discounts for noncontrolling interests, and the unified gift and
estate tax credit, John is able to reduce or even eliminate gift tax on
these shares.
- John gives 15 percent each to Beth and Carl, who immediately begin to
receive a share of ABC's income.
- When John dies, he leaves his 25 percent interest to Mary. These shares
are free of estate taxes, by virtue of the marital deduction. Adam purchases
the voting shares from Mary under a buy-sell agreement and acquires Beth and
Carl's nonvoting shares pursuant to mandatory call rights exercisable upon
John's death. These stock purchases are funded by life insurance.
The family's strategy allows John to maintain control of the company; gives
Adam an immediate ownership interest in, and ultimately control of, the company;
provides for John's wife; and gives Beth and Carl a current source of income and
an eventual exit strategy.
This is just one example of the many strategies available to provide for
family members inside and outside the business. To be effective, all of these
strategies depend on good communication among family members and sound
valuations of both business and non-business assets. If I can help you in
assessing your strategies, please call or email me at cindyj@bobermarkey.com.
BMF&C
The Fight Against Fraud - Fraud Prevention Tools
By Raymond H. H. Dunkle, CPA, ABV, CVA, CFE, Senior Manager
 In
our last issue, we offered some tips for protecting your company from
check fraud - things like maintaining tight security over your check
stock, reconciling your bank statements promptly and conducting periodic
audits. There are also some external fraud prevention tools that you can
use for additional protection. These include:
- Positive Pay - "While no fraud prevention method is foolproof,
Positive Pay is the best product in 25 years to deal with the problem of
forged, altered and counterfeit checks," states Financial Digest.
Here's how the service works: companies give their bank a list of all the
checks the company has written, and then the bank compares checks presented
for payment against those the company wrote. If any checks are presented
that aren't on the list, the bank alerts the company, which decides whether
to pay the check or not.
- Maximum dollar and stale dated review - With these services, checks
that are presented for greater than a specific amount or past a specific
length of time (as determined by the company) are automatically returned as
unpaid.
- Controlled disbursement - This service provides companies with
checking account disbursement totals early in the day. Each morning,
companies can review a list of which checks will be presented for payment
that day and flag any suspicious items for further review before they are
paid. Controlled disbursement is often used in conjunction with Positive Pay
for maximum check fraud protection.
- Information reporting - Most banks today offer various types of
information reporting services that let companies access detailed checking
account information in a variety of ways - online, phone, fax, etc.
If you would like to discuss opportunities to prevent fraud within your
organization, please don't hesitate to call or email me at rayd@bobermarkey.com,
or your Partner/Manager contact at Bober, Markey, Fedorovich & Company, any
time. BMF&C
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In this feature of InfoLetter, each quarter we provide a profile of
one of our professionals who is available to work with our clients and
friends.
Lori A. Sheets, CPA
Senior Manager |
Lori Sheets specializes in audits of nonprofit organizations,
manufacturing/distribution and retail companies. She has also performed a
variety of special projects for her clients including internal control reviews,
operational reviews, acquisition due diligence and process change
implementations.
Lori graduated from The University of Akron in 1987 with a Bachelor of
Science degree in Accounting, and in 1988 with a Bachelor of Science degree in
Finance. She was employed by a regional CPA firm in Cleveland from 1988 until
joining Bober, Markey, Fedorovich & Company in 1990.
"Working with our clients throughout the audit process is very
interesting. We have the opportunity to see their organizations operate, through
our observations and inquiries with various personnel from the planning process
and inventory observations to our candid discussions with company management.
This in turn, helps us serve their needs and address their concerns."
Lori currently serves on the Board of Directors for Greenleaf Family
Services, is Treasurer of Weaver Industries, and is also a member of the current
class of Leadership Akron. She is the Past Treasurer of Kids Voting Northeast
Ohio, United Way Management Assistance Program Instructor, United Way allocation
panel member, and Junior Achievement Project Business Instructor. Lori is a
member of the American Institute of Certified Public Accountants and the Ohio
Society of Certified Public Accountants. BMF&C
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