How Do Estate Taxes Even Work?

Kathy dies in 2021. She is a widow and her estate has a net value ( after paying off all debts) of $17m. The estate tax exemption is $11.7m in 2021. Kathy’s estate gets taxed on the balance ($5.3m) at the rate of 40% at the federal level. Around 14 states currently impose estate taxes as well. 

Which means that estate taxes can add up real quick and be more than 40% when paying federal+ state both combined. 

This is one of the reasons why estate executors might force you to sell the business and its assets. 

However, there are ways that might require some planning but can keep your business safe even after your death: 

1) Fixing an Installment Plan for Estate Taxes

Mr. A passes away, he has a will but no estate planning. A’s business is valued at $20m, let’s just say. He leaves his business to his two sons without enough money for estate taxes. His sons can choose the installment plan and keep the business running. They can pay estate taxes out of current and future profits over a period of 14 years at an interest rate of just 4%. 

That’s because the IRS charges 2% on the first $1.49m and approximately 4% on the remaining balance. 

Wait, there are actually ways to eliminate estate taxes altogether….keep reading..

2) Form an FLP which is a Family Limited Partnership( I spoke of it two weeks ago in my newsletter) or even an LLC: 

FLPs and LLCs can minimize and even avoid estate taxes. They help business owners shift current business income to lower tax bracket family members. Parents are general partners while children are limited partners with an ownership interest but no right to manage operations. 

In the case of corporation stock, each child can receive up to $32,000( from both parents in 2022) as a gift without having to file a gift tax return. 

You can even have an LLC with non voting membership interests for your children. 

Do not DIY. Consult a tax professional before attempting to form a FLP. 

3) Employee Stock Ownership Plans( ESOPs) for C-Corps: 

The tax code for ESOP is complex. They are generally considered as fringe benefits for a C-Corp. But they work for small businesses too. A C-Corp makes annual contribution of its stock or cash to an ESOP Trust( interesting, huh?) I will talk about such trusts in my upcoming blogs.  Overtime, stock ownership passes to the beneficiaries ( hard to explain because this is a complex strategy) of the trust who also are company employees. Employees have actual balances in the ESOP in proportion to their salaries. 

Please note that Estate Planning forms a key part of Tax Planning.