Estate Planning: An Uncomfortable Necessity For Business Owners

A Little Strategy Goes A Long Way When It Comes To Minimizing Your Estate Tax Burden

You probably don’t spend a lot of time thinking about your own mortality. Not many people do. But that doesn’t mean that you shouldn’t. Having an estate plan in place can provide you and your loved ones with the peace of mind necessary to prepare for the future without a lot of the financial stress and anxiety that usually accompanies death.

When you don’t leave your heirs with a plan, you effectively open your estate up to unexpected taxes. Furthermore, if your estate doesn’t have enough liquid assets to cover the estate tax, among other financial obligations, you could be unknowingly leaving your loved ones on the hook for a burden they simply can’t afford.

This article will provide you with a deeper understanding of the estate tax and other financial concerns that often plague families after their loved ones pass away. We will also go into a few other key reasons why having an estate plan in place is absolutely critical.

The Estate Tax Explained

The estate tax is a tax that is based on the value of your assets and paid by your estate. Luckily, everyone is allowed a lifetime exemption amount, which means any gifts made during your lifetime in excess of the annual gift tax exclusion is able to be deducted from this exemption amount. Currently, amounts over the lifetime exemption threshold are supposed to be taxed at rates of up to 40 percent.

The Tax Cuts and Jobs Act of 2017 increased the lifetime exemption from $5.45 million to $11.45 million per individual. In 2020, the exemption amount increased to $11.58 million per individual. The increased exemption amount is temporary and is scheduled to sunset, or revert back to $5.45 million per person (adjusted for inflation), Jan. 1, 2026.

Those who are planning to make large gifts between 2018 and 2025 can do so without worrying that they will lose the tax benefit of the higher exclusion level once it decreases at year-end 2025.

Even so, the COVID-19 crisis and the recent U.S. presidential election has increased uncertainty around the lifetime exemption amount. This is because the federal government will be looking to increase tax revenues to help pay for the COVID-19 stimulus.

Many experts believe that the lifetime exemption amount will be reduced in an effort to increase tax revenue. Additionally, prior to COVID-19, many politicians proposed estate tax reforms – including reducing the lifetime exemption amount to as low as $3.0 million.

Even if you believe your estate is under the current lifetime exemption amount, it is important to know the value of your business as the laws are always changing and the exemption amount will likely be reduced at some point in time.

Also, it’s important to note that estate taxes at the federal level are only part of the concern. Many states also have their own versions of an estate tax and they vary state by state. Be sure to work with a CPA or state and local tax expert who can assess your specific situation.

Download & Print Rea & Associates’ Personal Financial Records Worksheet to get you started.

Why Do You Need An Estate Plan?

Do you know how much your business is currently worth? If not, you are looking at the additional difficulty of determining the overall tax liability of your estate. Additionally, without a plan in place, your estate may have to pay more in taxes than is necessary, effectively reducing the value of your heirs’ inheritance. Plus, as mentioned previously, depending on how liquid your estate is (or rather, isn’t), your heirs could be left with the tax burden. 

Business owners should be especially sensitive to the importance of creating an estate plan – and a business valuation should be an essential component of your strategy. Not only is a business valuation good business sense, but it can also help you effectively determine whether your estate is taxable. With this knowledge, you can proceed with creating an estate plan designed to reduce the overall liability of your estate.

How To Reduce Your Estate Taxes

Gifting shares of your business during your lifetime is one way to reduce your estate tax and this can be done without relinquishing control over your company. When gifting non-controlling interests in your business, the IRS allows the use of discounts to reduce the value of the gift. 

Two discounts are typically applied to a closely held business:

  • Lack of control
  • Lack of marketability

A lack of control discount is applied when the interest in the business that is being gifted cannot result in changes within the business. A lack of marketability discount, on the other hand, relates to the liquidity of an ownership interest in a company. In other words, how quickly an owner can convert their interest into cash. Non-controlling interest is typically less marketable than the business as a whole. Combined, these discounts typically reduce the value of the business interest being gifted by 20-50 percent. 

Gifting is a great way to transfer your wealth to the next generation while maintaining control of the business you worked so hard to build. It also helps you better prepare the next owner(s) of the company to effectively run the business while facilitating a smooth transition.

Listen to episode 151, “Prepare Your Plan Or Plan To Fail (Estate Planning 101), on unsuitable on Rea Radio, Rea & Associates’ award-winning business podcast.

Don’t Discount The Discounts

Let’s say your business is worth $10 million. Upon retiring, you would like to pass down your business to your children. However, you aren’t quite ready to give up control. Using this scenario, you might choose to gift a 49 percent interest in the business to your children. Since your gift is a non-controlling interest, discounts could be applied to reduce the overall value of the gift. For example, using a combined discount of 35 percent, the value of the gift would be $3.19 million instead of $4.90 million, with the remaining lifetime exemption amount setting at $8.39 million ($11.58 million – $3.19 million).

Upon your death, the remaining 51 percent of your company will be given to your children, which would reduce the lifetime exemption amount to $3.29 million ($8.39 million – $5.10 million) for the remainder of the assets in the estate.

If you had waited until your death to pass down the business, the value of your business in the estate would be $10 million, which would leave just $1.58 million for the remainder of your assets. But with the discounts of $1.71 million, your estate could realize a tax savings of $686,000 assuming your other assets put the value of your estate over the lifetime exemption amount.

Celebrities aren’t immune to estate planning faux pas. Find out what happened after the death of the Queen of Soul, Aretha Franklin, when she neglected to pull together an estate plan.

You Can’t Afford To Wait

The total amount of discounts you can claim will greatly reduce the total amount of taxes your estate (or your heirs) will have to pay. Sure, estate planning can be an uncomfortable topic of conversation, but it’s important – for you and for your family.

Contact me directly at 614.923.6585 or or click here to speak with a member of the valuation and transaction advisory team or estate planning at Rea & Associates to learn more about the services we offer that are designed to put you and your family in the best position possible moving forward.

By Jack Miklos (Dublin office)

Disclaimer: The information presented in this article is for informational purposes only. Please consult an estate planning specialist or valuation and transaction advisory services expert for advice regarding your own unique circumstances.

Looking for more estate planning assistance? Check out these resources:

[PODCAST] Estate Planning Awareness: Why It Matters & What To Do

[ARTICLE] When Do You Need A Business Valuation?

[PODCAST] Back To The Basics Of Business Valuations