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Freeze and Squeeze

Freeze and Squeeze

Why planning works to preserve family businesses

 

Despite all the press coverage about the death tax, in reality, few people worry about confiscatory estate taxes.  However, those owning family businesses and farms seem to provide a disproportionate share of federal and state revenues at death.  Although there is some temporary federal relief offered if you accept the moving goal post formula for estate taxes, the operative word is “temporary”.  A significant and new problem for many is the increasing percentage of estates subject to higher income taxes and the recently enacted estate and inheritance taxes imposed by revenue-starved states. 

 

The solution?

Consider making charitable gifts of those assets that trigger both income and estate tax at death (income in respect of a decedent or IRD), and keep the estate from ballooning in value.   With a little prior planning, there is no need to pay unnecessary taxes if owners freeze the value of their growing business and transfer it before tax liabilities mount up.  How does that work?  Easily, but few taxpayers take advantage of their right to make tax-free gifts to heirs on a regular basis.  It is a shame, because over time, significant value can be compressed and given via lifetime and annual exclusion gifts, especially if husband and wife join to make full use of gifts to children, in-laws, and grandchildren.  For many families with four married children, and grandchildren, it is common for half a million dollars in estate value to be transferred free of tax.  By making those gifts repeatedly over the years, most estates would see significant tax savings.  Yet few families take advantage of this right. Why?  Most family business owners resist making gifts fearing loss of control, and are unwilling to take a proactive long-range view of the planning process.

 

Plan now, notlater

Sam Walton, founder of the Wal-Mart empire, is a great example of successful transition tax planning.  He passed the bulk of his business interests to his heirs with little tax erosion by preparing the plan early in his career.  Sam and Helen started their retail business after World War II with $5,000 in savings and $20,000 borrowed from Helen’s father; then built that stake into a multi-billion dollar marketing behemoth.  Along the way, they learned lessons in business succession planning and resolved to create a family owned business, Walton Enterprises, in which they transferred 20% of their business interests to each of their four children (Rob, John, Jim, and Alice) and kept their remaining 20% portion as separate shares.  When Sam passed away in 1992, owning only his 10% ownership interest in the $26 billion Walton business, the taxable value of his estate was much smaller because of his prior gifts.  Although specific details are not available for the entire Walton zero estate tax plan, Sam’s 10% ownership of Walton Enterprises passed tax-free through a marital trust for his wife.  As reported by Forbes magazine’s best estimates of family wealth in the annual “Forbes 400” (September 2002), his planning meant that each of the five principal Walton heirs is now worth $18.8 billion.  When Mrs. Walton passes on, her interests divide when the non-voting shares flow to the Walton charities, while the voting shares transfer to their younger heirs who will continue to control the retail, banking and real estate business.  

 

The planning concept is simple.  The best way to reduce or eliminate estate taxes is to freeze the value and give it away before assets appreciate, so worth grows in the heirs’ hands.  This transfers the tax value.  Maintaining control is a different issue; keep the managing interest separate and retain command of the family business.  The advantage of passing non-voting ownership interests to heirs is that discounting and compression may result in a lower tax value when heirs do not have significant management influence.  Typically, the IRS allows independent appraisers to lessen the taxable value of a business if there are minority interests, limited marketability, and lack of control.  That is the “squeeze” in the planning, and it means that it becomes easier to pass a business at a discount.  This is not “do it yourself brain surgery”; proper planning and legal procedures must be used, so seek competent counsel and do it right.

 

Had that unplanned growth and value stayed in Sam and Helen Walton’s hands, and been subject to tax under current rates, the tax bill would exceed $47 billion today.  It would be hard to imagine any family business being unaffected by a need for that kind of liquidity in just nine months after the death of a principal owner.

 

What Sam Walton achieved through effective planning –

  • Reduced his gift and estate taxes
  • Improved his planning options
  • Protected some of his assets from creditors
  • Transferred assets to heirs without losing control
  • Kept his children tied to the family business by shifting an equity interest to heirs
  • Achieved flexibility of structure and design through the partnership
  • Avoided probate by using methods that operate by contract
  • Ensured privacy for his dealings
  • Leveraged use of his tax-free transfers, like the annual exclusion gifts that are now $11,000 and the new $1,000,000 applicable exclusion or $1,100,000 generation skipping exemptions.
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Case Studies and Articles

Statistical Information on Injuries in the Horse Business – Summary by Emmy R. Miller, PhD, RN

Statistical Information on Injuries in the Horse Business – Summary by Emmy R. Miller, PhD, RN

am a nurse working in head injury research.  Someone mentioned that they didn’t know the statistics for

equestrian related head injuries.  Well, have a few sources here and will provide some of them for you.

Sports Medicine 9(1):36-47, 1009

Synopsis:  The most common location of horse-related injuries is:

         upper extremity 24-61% (reported in different studies)

         lower extremity 36-40%

         head and face 20%

The most common type of injury is:

         soft tissue injury 92%

         fractures 57%

         concussion 15%

The most frequent consequence of injury is:

         hospitalization 5%

         residual impairment 2% (i.e. seizures, paralysis, cognitive impairments, etc)

         death 1%

JAMA, April 10, 1996, vol 275, no 14, p. 1072

Synopsis:   During 1992-93 in Oklahoma, horseback riding was the leading cause of sports-related head injury, (109 of 9409 injuries or 1.2% associated with riding and 23 additional injuries attributable to horses)  Of the 109, there were 3 deaths (3%).  The injury statistics were:

         males 55, female 54

         age range 3 yr to 71 yrs, median 30 yrs

         most commonly seen in spring and summer

         48% occurred on Saturday or Sunday

         95% involved riders who struck their heads on the ground or a nearby object after falling from the horse

         4% were kicked or rolled on after falling from the horse

         1% hit head on a pole while riding and fell to the ground

         90% were associated with recreational activities

         10% were work-related

         107 were hospitalized with a median LOS of 2 days

         79% had one or more indicators of a severe brain injury, including

1.        loss of consciousness 63%

2.        posttraumatic amnesia 46%

3.        persistent neurologicsequelae 13% (seizures, cognitive/vision/speech deficits, motor impairment)

Among the 23 injuries not riding related, 21 (91%) resulted from a direct kick to the head by the horse, where died immediately and 2 required CPR.  13 of these injuries occurred in children less that 13 yrs old.

Journal of Trauma 1997 July; 43(1):97-99

Synopsis:   Thirty million Americans ride horses and 50,000 are treated in Emergency Departments annually. Neurologic injuries constitute the majority of severe injuries and fatalities.  A prospective study of all patients admitted to the University of Kentucky Medical Center with equine-related trauma

from July 1992 – January 1996 showed the following:

         18 of 30 (60%) patients were male

         11 (37%) were professional riders

         24 (80%) were head injuries and 9 (30%) were spinal injuries (4 with both)

         age ranged from 3 to 64 yrs

         patients died (17%)

         2 suffered permanent paralysis (7)

         60% were caused by “ejection or fall from horse”

         40% were kicked by the horse, with 4 of these sustaining crush injuries

         6 patients (20%) required craniotomy (i.e. brain surgery)

         24 patients (80%) were not wearing helmets, including all fatalities and craniotomy patients

“Experience is not protective; helmets are.”

This last line is a direct quote from this article.  hope you find these statistics helpful.

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