How to shrink your estate without harming the value of your business Featured

8:00pm EDT September 25, 2010

You’ve put everything you have into your business, spending years to create something of value. But what’s going to happen to it after you’re gone? If you don’t plan for that eventuality, the value of your estate could be greatly diminished, and even create a financial hardship for your heirs, says Douglas Sockman, CFP®, ChFC, CLU, a financial advisor at Skylight Financial Group.

“Developing a plan is key,” says Sockman. “Plan for what you know today; then monitor it and make changes along the way.”

Smart Business spoke with Sockman about how to shrink your estate without harming the value of your business.

What steps can business owners take to shrink the value of their estate?

One of the easiest things to do is to make gifts. Every U.S. citizen can give $13,000 per year to each and every family member — or anyone else for that matter — without paying a federal gift tax. If you are married, your spouse can do the same. The gift can be in the form of cash, bonds, stocks, securities, business interests, real estate, etc.

Can you reduce your estate by a larger amount?

In addition to ‘annual gifting,’ every U.S. citizen can make tax-free gifts during their life totaling $1 million; so a husband and wife could make additional tax-free gifts of $2 million. But, any post-gift appreciation is not included in your taxable estate.

If a business owner has a $2 million business and it is growing by 30 percent a year, he or she could get that $2 million out of the estate — as well as the appreciation on it — by gifting it to his or her children. Once you use that $1 million exemption, it is gone, although you can still make $13,000 gifts each year.

However, these tax-free gifting opportunities might not completely ‘do the tax trick’ when the value of the business or the estate is very large. Even after all this tax-free gifting, a significant estate may remain subject to estate tax rates of up to 55 percent. Also, a downside to giving property away is that you’re giving up complete control of what you give away.

Are there other ways to reduce the value of an estate?

Another gifting technique is to set up a grantor retained annuity trust (GRAT) to which you gift assets, especially those that are highly appreciating or income producing. The GRAT will pay you income over a set number of years (within limits). At the end of the term, any remaining assets pass to the beneficiary of the GRAT, typically children. If you survive the term, then the GRAT assets are not included in your estate and any appreciation has escaped estate taxation. Because of the way GRATs work, you make a ‘discounted gift,’ due in part to the time value of money.

Assume you have a $5 million business and you want to gift the entire amount to a GRAT that lasts for ten years and pays you 7 percent every year, which is $350,000. As a result, that $5 million business is ‘discounted’ down to almost $2 million gift-tax value.

Does the down economy make this a good time to remove assets from your estate?

Many asset values are ‘depressed,’ or at least a lot lower than just a few years ago. So now could be a good time because you would be removing them from your estate at a lower value, which has less of an impact in terms of gift tax consequences. If your $1 million business has taken a hit and is now valued at $700,000, you can remove from your estate a $700,000 asset that could soon be back to be worth $1 million. In effect, this would ‘save’ you $300,000 of future tax-free gifting. The bottom line is that if you can get an asset out of your estate that has the potential for high appreciation, or one that is appreciating quickly, it may be a good idea to do so now.

What can be done to pay for those high estate taxes?

Life insurance is a traditional — and popular — way to help pay for estate taxes. Other ways of paying estate taxes are for your executors to use any available cash, sell assets or borrow money.

When life insurance is used, it is typically owned by a trust that you set up — so that the death benefit is not included in your taxable estate, which if you owned, would just compound the problem. Many people do not realize if you own a life insurance policy on your life, the death benefit is included in your taxable estate.

Let’s look at an example. If your heirs need cash to pay estate taxes because your estate contains illiquid real estate or the business that they (you) do not want to sell, the proceeds from the death benefit can be used to help pay the taxes. In addition, the cash generated by the life insurance death benefit might come in handy when income taxes have to be paid on inherited IRAs.

Some people are insurance averse; but once they understand that it is difficult to invest those dollars and get the rate of return they would get leveraging the insurance company dollars via the death benefit, an irrevocable life insurance trust technique could be a wise business decision. This is a simple way to make the estate ‘whole’ and keep life insurance out of the estate so it is not taxed and everyone benefits.

Douglas Sockman, CFP®, ChFC, CLU, is a financial advisor at Skylight Financial Group and a member of their Advanced Planning Team specializing in personal financial planning and serving small business owners. Reach him at or (216) 592-7316. Douglas Sockman is a registered representative of and offers securities, investment advisory and financial planning service through MML Investors Services, Inc. Member SIPC. 1660 W. 2nd St. Ste 850. Cleveland, OH 44113. 216-681-5680. CRN201209-139871.

The Economic Growth and Tax Relief Reconciliation Act of 2001 contains a ‘sunset’ provision that repeals the estate and gift tax provisions of this Act as of January 1, 2011. Consequently, all estate and gift tax code changes made under the Act will then revert to their status prior to enactment. Unless there is further legislation, these provisions will only be effective through the year 2010. The information provided herein is not written or intended as tax or legal advice and may not be relied on for purposes of avoiding any federal tax penalties. Entities or persons distributing this information are not authorized to give tax or legal advice. Individuals are encouraged to seek specific advice from their personal tax or legal counsel.