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The estate-tax toll on small firms

Nation's Business, August, 1997 by Joan Pryde

The federal estate tax may not have killed Gordon Perkins' business, but the administrative headaches and the costly drain on his resources it has caused are another matter.

His mother, Ella Perkins, who was a co-owner of Perkins Flowers Inc. in Lapeer Mich., died in March at age 83. Gordon is still trying to determine the value of her estate and to calculate the estate-tax liability--a process he says will take several months altogether, not to mention more than $20,000 in legal and accounting costs.

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It's not as if the mother and son hadn't prepared. Three years ago they agreed to several estate-planning steps. Ella relinquished part of her ownership and became a minority stockholder in the firm to minimize the amount of estate taxes due after her death. Gordon sank $60,000 into monthly payments on a life-insurance policy for his mother that will pay out $200,000, which he hopes will be enough to cover the estate-tax bill. If it's not, he is prepared to sell a 43-acre tree farm that is part of the business.

But it galls Gordon that he has used up so much time and money preparing for and trying to minimize estate taxes. "We weren't blindsided by this; we did our estate planning," he says. "But I can tell you this for sure. At the very least, it's going to repress the growth of my business for some significant amount of time."

That, according to small-business advocates, is the crux of the problem: The estate tax carries too high a price tag for small, family-owned enterprises, whether they end up paying the tax or finding a way around it with careful estate planning.

For small-business owners like Perkins, however, and for owners of family farms, help may be on the way--though it's not clear how much help. Congressional leaders and President Clinton included estate-tax relief in their balanced-budget proposals, and House-Senate conferees are working out the details. (See the article "Reform Plans On Congress' Agenda.)

A Trio Of Levies

Federal estate taxes--or "death taxes," as they have been dubbed--were first levied by Congress in 1916. The current estate tax is actually one of a trio of so-called wealth-transfer taxes; the other two are the gift tax and the generation-skipping tax, which carries a flat rate of 55 percent on assets passed to grandchildren or great-grandchildren.

Since 1976, the estate and gift taxes have shared the same rates, ranging from 37 percent to 55 percent, depending on the value of the estate. (See the chart on Page 24.) Each citizen has a one-time exemption of $600,000--called the unified credit--from either tax. In addition, an individual may give up to $10,000 each year to anyone--with no limit on the number of gifts--without paying the gift tax.

The taxes on an estate are generally due nine months after the death of the individual, but Internal Revenue Service rules allow estates involving closely held businesses to make installment payments--with interest--over as long as 14 years. In addition, the first $1 million of the value of the business is eligible for a 4 percent interest rate. Yet despite the favorable terms, IRS records show that very few small firms opt for the extended payments.

On the surface, it may seem surprising that the estate tax is such a hot issue among owners of small businesses and farms. IRS figures published in April indicate that only a fraction of taxable estates are small companies or farms. The figures show that in 1995, the IRS collected a net $11.8 billion from 31,564 taxable estates. Of that total, only 5,397 estates, or about 17 percent, contained closely held businesses or farm assets.

But small-business advocates insist that the IRS figures fail to give the total picture. Not included in those numbers, they say, are an undetermined number of business owners who eliminated their tax liability with savvy estate planning.

A 1996 survey of 1,003 small-business owners nationwide underscores that point. Conducted by researchers at Kennesaw State University in Kennesaw, Gal, the survey found that more than half of the respondents believed that their estates would be hit with a tax bill that would limit their firms' growth potential. About one-third of the respondents said payment of the expected estate tax would require the sale of part or all of their businesses.

Moreover, the number of small firms that will be affected by the estate tax is likely to grow. Estimates released in April by Congress' Joint Committee on Taxation indicate that the chances of a small business being subject to the effects of the levy will increase substantially in the next few years. According to a report by the committee, the number of taxable estates is expected to nearly double in the next 10 years, from 37,200 this year to 73,200 in 2007.

For business owners who worry about estate taxes, there is some comfort, however: Financial planners maintain that there are many ways to minimize liability.

One of the principal steps that companies take in preparing for an expected estate-tax bill is to buy life insurance on the owner or owners, making certain that the policy is owned by the company or a life-insurance trust and that the proceeds are kept out of the owner's taxable estate.

Business Services Industry

The estate-tax toll on small firms

Nation's Business, August, 1997 by Joan Pryde

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