The Tax Reform Act: A Gift with an Expiration Date (For the Business Owner)

Sometimes selling involves taking existing plans and reviewing them in light of changes in personal or business circumstances, changes in goals — or changes in outside factors, such as tax law. For many business owners, their estate plans need to be reexamined, and possibly changed, because of an outside factor: the passage of the Tax Reform Act of 2010.

Especially for business owners, TRA 2010 means that assets can be valued, discounted and transferred on a favorable basis, often without any gift or estate tax consequences. Income tax benefit extensions help make some of these plans even more attractive. TRA 2010 provides an outstanding opportunity for producers to restart discussions with their higher-end prospects and clients, particularly those who own businesses.

Many business owners may have existing estate plans, so producers must show how TRA 2010 is, in many ways, a gift with an expiration date: Act now or pay more taxes in the future. Let’s look at a few opportunities that have come out of this legislation.

Buy-sell and exit planning

TRA 2010 extends lower tax rates on income, dividends and capital gains for two years. These lower rates can simplify buy-sell arrangements and exit planning where a sale of the business is envisioned. The higher exemption may simplify gift-oriented exit planning strategies in which estate taxes are a bigger concern than the owner’s financial security.

Owners should obtain a business valuation to see if exit strategies are on track after the recession. Buy-sell agreements should be reviewed to see if the structure continues to make sense and funding is adequate.

Inheritance equalization

The net worth of many business owners consists mostly of the business. In an instance in which some children participate in the business and others do not, life insurance can provide for a fair division of assets while making sure that control and ownership remain with the children working in the business. The increased exemption may simplify premium funding and minimize estate tax considerations.

Grantor retained annuity trusts (GRAT)

GRATs are popular wealth-transfer tools that can be used independently, but are often employed to provide funding for exit strategies from premium financing and split-dollar life insurance arrangements.

Despite much discussion, Congress chose not to reduce GRAT utility by restricting short-term GRATs orimposing a minimum remainder requirement; thus, GRATs will continue to be effective wealth-transfer tools. Often, a business owner can discount the value of a business interest and then further reduce the value, conceivably as low as $0, using a GRAT. Note that Congress can choose to impose restrictions at any time, so this opportunity may not be around for long.

Valuation discounts

Valuation discounts (e.g., minority interest, lack of control or lack of marketability) have been a key tool to reduce the gift tax value of transferred assets. As with GRATs, Congress chose not to impose additional restrictions on valuation discounts; thus, they will continue to be useful in wealth-transfer planning.

Congress can choose to impose additional restrictions at any time and valuation discounts are the subject of ongoing scrutiny by the IRS, so careful planning is required.

Seize the moment

Recent events prove that predicting future tax law changes is a risky business. Until almost the eve of 2010, most observers were confident thatCongress would not allow the federal estate tax to expire. After the law expired, many assumed a compromise would be quickly reached. As the year waned without action, it became plausible to believe that Congress would be unable to reach a compromise before 2011. Instead, on Dec. 17, 2010, President Obama signed into law TRA 2010.

The economic and fiscal uncertainties facing the country may or may not dictate that transfer and income tax rates will remain at current levels. For the moment, however, savvy producers have an opportunity to work with business owners to leverage existing estate plans. Sharing examples of these specific tax savings opportunities helps make the intangible real, and can lead to action by the business owner.


Steve Parrish, JD, CLU, ChFC, RHU is a national advanced solutions consultant with the Principal Financial Group, based in Des Moines, Iowa.


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