The estate-tax toll on small firms

Nation's Business,  August, 1997  by Joan Pryde

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There's always the ultimate solution: An owner can sell the business during his or her lifetime, although doing so creates another set of tax problems. Nonliquid business assets are indeed replaced with cash that can be used to cover the estate tax. But often the whole point of maintaining a business is to be able to pass it on to the next generation. So selling a business is usually the last resort.

For many small-business owners, the flap over estate taxes boils down to being able to save their business and put the money they earn back into their company instead of sending it to Uncle Sam or paying it out to estate-planning professionals.

The key question for lawmakers, says Drew Mendoza, program director for the Family Business Center at Loyola University Chicago, is this: Who should keep the money--the federal government or the business owner? Mendoza's answer: "I firmly believe that $100,000 in the hands of an entrepreneur will have a better return than that same $100,000 has in the hands of the government."

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RELATED ARTICLE: Reform Plans On Congress' Agenda

Congress is on the verge of providing at least some incremental estate-tax relief.

Estate-tax provisions contained in separate balanced-budget bills approved in late June by the House and Senate contain a number of similarities and one key difference. Among the similarities, the House and Senate packages provide for a phased-in increase in the $600,000 personal estate-tax exemption to:$1 million. The House bill would phase in the increase over 10 years; the Senate bill calls for nine years.

Under both tax packages, the exemption would be indexed for inflation annually after reaching $1 million, The $600,000 limit hasn't changed since 1982. If the exemption had been indexed all along in step with the Consumer Price Index, it would now be $838,000.

In addition, both measures::would extend to 24 years from 14 years the Internal Revenue Service's special installment-payment period for estate taxes owed by closely held businesses.

In a key difference between the two tax packages that will have to be resolved by a House-Senate conference committee, the Senate bill would target family businesses and farms by adding on top of the exemption an exclusion for the first $1 million of value in qualified family-owned businesses.

When combined, the proposed $1 million exclusion and the current $600,000 exemption would immediately put $1.6 million in small-business estate value out of reach of the IRS. Within a decade, that amount would rise to $2 million.

The conference committee is expected to complete its work before Congress adjourns for August.

Before the conferees got to work in early July, President Clinton proposed modifications in the tax-cut package, including an alternative approach to cutting estate taxes. Clinton proposed excluding an additional $900,000 from estate taxes for certain family-owned businesses and farms. Thus, Clinton would allow a qualifying individual to pass tax-free to heirs a total of $1.5 million--up from the current $600,000.