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Estate Planning

To avoid losing your business to an outsider – or worse, a competitor – after your death, plan now for an orderly transfer of your estate.

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The importance of arranging for the orderly transfer of your business
upon your death is often overlooked amid the day-to-day demands
of running a business. However, shop owners who ignore this issue
risk leaving their families no choice but to sell the business
– or worse, to face the possibility of having a competitor take
control – because they can’t pay administration expenses or taxes.

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But estate planning involves more than just trying to lessen estate
taxes. It entails laying down a plan for the distribution or transfer
of your business after your death.

To avoid complications and ensure orderly transitions, there are
several ways owners can plan their estates. Some of the most common
and effective ways are cross-purchase agreements, redemption agreements,
the implementation of Section 6166 and the use of qualified real
property.

Stock Redemption and Stock Purchase Agreements

The most common way business owners can arrange for the transfer
of their business interests at death is by entering into agreements
with their co-owners, known as a cross-purchase agreements, or
with their companies, known as redemption agreements. Transfers
of stock under a properly structured cross-purchase or redemption
agreement are generally tax free to estates.

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The owners can assure a fair price to both the family and the
business successors by binding their estate to sell and binding
the company or co-owners to buy the stock at a predetermined price.
The basis of your appreciated stock is automatically "stepped
up" at death to its fair market value. The parties also should
be certain the agreement price is adjusted frequently enough to
take into account changes in stock value, either by amending the
agreement or by using a formula that automatically accounts for
such changes.

In many cases, business owners may not have the financial resources
to buy stock when it becomes available, for example, when a co-owner
passes away. Insurance can often fill this need.

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Stock Redemption to Pay Death Taxes and Expenses

Section 303 of the Internal Revenue Code (IRC) has long permitted
estates to redeem stock to pay for funeral and administration
expenses, as well as death taxes, without requiring the funds
distributed to the estate to be taxed as dividends.

This favorable treatment, however, is only available if the value
of the stock represents a sufficiently large percentage of the
estate’s total value. Section 303 permits such a redemption if
the value of the stock held by an estate is greater than 35 percent
of the total value of the estate after subtracting the value of
deductible debts, expenses, taxes and losses.

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Deferral and Extension of Federal Estate Payments

Congress – recognizing the tax burden on those whose estates consist
largely of the value of their businesses and wishing to avoid
forcing such estates to sell their stock at a fraction of its
value to pay taxes – enacted provisions permitting installment
payments and even deferral of the tax for a limited period.

Section 6166 of the IRC covers any estate in which the value of
an interest in a closely held business exceeds 35 percent of the
estate’s total value after subtracting deductible debts, expenses,
taxes and losses. It permits such an estate to pay the portion
of the tax attributable to the closely held business interest
in two to 10 annual installments and to defer the first installment
payment for up to five years after the due date of the estate
tax return. During the deferral period, only annual interest payments
must be made.

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While the interest rate on the unpaid principal will generally
be the basic Internal Revenue Service rate; a separate, special
provision charges only 4 percent interest on a limited portion
of the unpaid amount.

Section 6166 warrants consideration in some instances, but it’s
important to understand that its use can cost the estate a good
deal of time and money since the estate will remain open for an
extended period of time. As an example, the Tax Reform Act of
1986 requires new and existing estates to make estimated income-tax
payments. Other planning devices, such as redemption or cross-purchase
agreements, are generally more effective.

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Special-Use Valuation

Another estate-tax relief provision for closely held businesses
permits valuation of certain "qualified real property"
at its actual use rather that its highest and best use. This provision,
IRC Section 2032A, applies to real estate used in farming or business
if such property constitutes more than half the federal gross
estate and if certain other requirements are met.

The Importance of Planning

Business owners need to take a close look at their estate planning
to ensure the smooth continuation of the business after they die.
Those who fail to plan may force their heirs to sell the business
or lose out to a competitor.

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To avoid such complications and ensure an orderly transition,
consult with your lawyer, accountant and financial planner before
deciding on a specific course of action. The time you take now
preparing your estate will help to someday make a difficult period
a little easier on those who proceed you.

Writer Barrett W. Butlien is a small-business planning specialist
and a representative of Allmerica Financial – The Westchester
Group in Tarrytown, N.Y. He’s also a registered representative
of Allmerica Investments, Inc., a registered broker-dealer. For
more information about estate planning options, call Barrett at
(914) 332-5700, ext. 278.

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Check It Out

To ensure an orderly transfer of your business upon your death,
consider the following estate-planning tips.

  • The most common way business owners arrange for the transfer
    of their business interests at death is by entering into cross-purchase
    or redemption agreements.

  • Owners can assure a fair price to both family and business
    successors by binding their estate to sell and binding the company
    or co-owners to buy the stock at a predetermined price.

  • Under certain provisions, Section 303 of the Internal Revenue
    Code (IRC) permits estates to redeem stock to pay for funeral
    and administration expenses, as well as death taxes, without requiring
    the funds distributed to the estate to be taxed as dividends.
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  • Section 6166 of the IRC covers any estate in which the value
    of an interest in a closely held business exceeds 35 percent of
    the estate’s total value after subtracting deductible debts, expenses,
    taxes and losses. It permits such an estate to pay the portion
    of the tax attributable to the closely held business interest
    in two to 10 annual installments and to defer the first installment
    payment for up to five years.

  • Another estate-tax relief provision permits valuation of certain
    "qualified real property" at its actual use rather that
    its highest and best use. This provision, IRC Section 2032A, applies
    to real estate used in farming or business if such property constitutes
    more than half the federal gross estate and if certain other requirements
    are met.

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