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How Estate Tax Changes Could Affect Your Small Business

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Guest contributor Randall D. Fisher explains the impending 2013 estate tax changes and what they might mean for your small business.

“Taxmageddon” and the “Fiscal Cliff” follow me everywhere.

They snake into headlines, soundbites, and the subject lines of financial spam. Yet it’s not their ubiquitousness that I find so distressing. It’s not the former term’s connotation that the Mayan forecast will be vindicated in the most tortuously mundane extinction event in terrestrial history (the asteroid claims the tyrannosaurus rex; the IRS claims the homo sapien). It’s not the latter’s implication that we’re too shortsighted to look past the Roadrunner and the ACME Rocket Skates to see the gaping chasm beyond.

It’s the way those cartoonishly ridiculous media terms fail to encapsulate the sobering reality for small business owners like me: tomorrow is not guaranteed—for either owner or business.

In the past, a small business with an established succession plan has been able to outlive its owner long after God and the IRS have presented the owner their respective bill. In the latter case, that bill—the estate tax—has been a nonfactor for nearly all of the small business owners who died in 2011 and 2012.

That’s about to change.

In 2012, only 3,300 Americans are expected to pay federal estate tax, generating $12 billion in revenue. In 2013, those statistics are set to explode: 52,500 people are projected to be liable for an estate tax total of $40.5 billion (Source). That’s what happens if Congress lets your estate tax exemption roll back from $5 million to $1 million and allows your tax rate to inflate from 35 percent to 55 percent.

So what do “Taxmageddon” and “Fiscal Cliff” really mean for my small business? For yours?

Well, keeping your business in the family (or wherever you want to keep it) is about to get a whole lot harder if you’re over the limit. Actually, it could be nigh impossible. If you die in 2013 with assets in excess of $1 million—not a high threshold for someone with equity in a small business and a home—your business could die with you.

The combination of lowering the exemption and increasing the rate so sharply will cripple small businesses whose owners lack sufficient liquid assets to pay the estate tax. If you own a home and business, your surviving family members are going to sell the company before the house to cover the bill—and their options will be limited with so little time to generate revenue. This is especially true of businesses that have most of their assets tied up in real property, like family-owned farms and manufacturers.

Who will scoop up these businesses? Nobody can be sure, but it may not be someone you would have wanted to take over your company. That may not have much financial impact on some companies but those in industries like the service sector, where much of the value of the business is tied to the personality of the business owner, might not survive the abrupt change of leadership. My own law office (I am a sole practitioner) would struggle with that.

The estate tax was never meant to exclusively raise revenue for federal expenses; rather, it was created to also prevent a few super wealthy families from simply inheriting every property or business in America ad infinitum. Indeed, those who consider the estate tax to be one of the most inefficient sources of federal revenue credit even more that latter effect: to encourage entrepreurship and give the little guy a chance for a legacy of his own. That has been forgotten in this budget crisis and, correspondingly, the estate tax changes looming are severe enough to take that chance from some of those little guys, forcing them to sell—presumably back to the bigger ones.

Admittedly, that’s not an easy problem to solve, but broadening the discourse is better than wrapping it up in handy little phrases that put makeup over a gash. Start with your professionals. Meet with your lawyer and your accountant and play a game of what if. Walk through the scenarios of if something happens to you or your business partner(s). If need be, talk to a lawyer about a new or a revised buy-sell agreement. Talk to your accountant about modifying your business needs to corral cash for a “rainy day.” Finally, talk to your financial professional about life insurance options.

Our businesses are our legacies; the conversations will be worth it.

About the Author

Annapolis attorney Randall D. Fisher has practiced for over 20 years and maintains the highest peer review rating for ethics (AV Preeminent) by Martindale-Hubbell. He blogs about on estate planning, asset protection, and business law for the Fisher Law Office.

 

Posted in: Business, Tax & Audits
COMMENTS
  1. Philly Planner says:
    November 10, 2012 at 8:39 am

    What about the extension to pay estate tax under Section 6166 when an interest in a closely-held-business is over 35% of the decedent’s adjusted gross estate? Won’t that help somewhat address this concern?

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