With President Obama signing the American Taxpayer Relief Act of 2012 on January 3, 2013, families can begin planning their estates knowing the updated terms. Now is the best time to assess the Act’s impact and evaluate tax-advantaged wealth transfer opportunities.
The American Taxpayer Relief Act of 2012 permanently sets the unified gift and estate tax exemption amount to $5 million, subject to annual inflation adjustments; and permanently provides for a maximum estate tax rate to 40% for descendents dying after 2012. For high-net-worth families and those with closely-held family businesses, this means reviewing their estate plans and seeking vehicles to mitigate tax exposure.
Unfortunately, estate planning can also cause family feuds over inheritance, often leading to litigation that can become lengthy and costly with no clear winner. From our experience, family litigation occurs not from a lack of trying to solve the issue, but from a lack of planning. Below are key tactics we suggest to help take advantage of potential tax cuts, as well as to avoid family battles over wealth transfers.
- Overcome the concept of fairness. One of the most common issues is when parents try to be “fair” in order to ensure their children get along. In this situation, the parents are also typically trying to protect and keep the legacy asset, whether it is a business or a home, in the family and on a growth trajectory. If one sibling is invested and interested in the family business, while the other sibling is not interested in the family business and wants to pursue a lifestyle that is quite different from the other sibling, splitting the business “fairly” between the two siblings, i.e. giving each sibling an equal portion of the business, is likely to cause tension and unnecessary disagreements and legal battles down the road.
- Transfer assets based on a natural flow. Instead of transferring assets equally, focus on what makes sense for the individual you are transferring the asset to. For example, if only one sibling is interested in the family business, he or she should be considered to own the family business in the future. If the other sibling is not interested in the business, other mechanisms can be set into place for transferring different assets to that child.
- Protect family assets. Each sibling's desires and needs are different. The individual might be young with other goals, might not have the same interests as the family, or might have special needs. In these situations, certain mechanisms such as trusts can be set up to protect both the individual and the family assets. For example, an individual can receive income for life and have a trustee appointed to manage the financial assets.
- Make major decisions with every family member in the room. When it comes to transferring assets or discussing the future, the family needs to be on the same page. Not doing so can lead to family tension and legal battles in the future.
For example, the parents might transfer assets to the daughter without telling the son. If the son finds out, he can begin to question how much was given and imagine the reasons for him not to be included. He can also feel resentful towards the sister or the parents. Openness and transparency prevents unnecessary misunderstandings or resentment amongst the family members.
- Do not wait for the original founder of the family business, or a parent, to pass away. A simple fact: the more you talk now, the better it will be for your family’s future.
Many problems arise after the individual who has the majority of the wealth is out of the picture. When mom or dad doesn’t address an issue, the siblings begin to feud.
- Evaluate what you can and can’t afford to transfer. The first step in beginning the estate planning process is to get an estimated current value of the asset portfolio of the estate. Determine the assets that are more likely to appreciate in value, giving considerations to those that also carry other intangible values, such as the family legacy.
Oftentimes, the parents might say, “the kids need to financially take care of themselves. We need to focus on ourselves.” However, after evaluating the estate, they might realize that they can afford to transfer wealth now and minimize what they will give in taxes to the government later. One strategy is transferring hard assets, such as a real estate property, which are likely to increase in value but may not have a good income stream. By keeping liquid assets such as cash and stock, the parents do not have to compromise their standard of living. This way, the asset transferred is not the asset parents depend upon for living expenses.
- Treat estate planning as an ongoing process. Every individual has life-changing events - marriage, children, divorce, sale of a business, stock options, IPO - along with changes in beneficiaries. We often refer to this as a “milestone review.” When a financial or significant life milestone occurs it is critical that the estate plan is updated.
For instance, if one of the children gets married, his or her spouse can greatly influence the individual’s opinion on how much he should be involved with the family business, etc. It is important for both the family, and the third party advising the family, to identify the goals and values of the estate and how these milestones will impact them.
- Pick the right professional advisor. Estate planning is a very personal business for both the advisor and the individual client. Look for someone you trust who will bring a personal interest to the relationship. As gifting involves giving up some control and is not something that can easily be reversed, understanding family dynamics and getting family members comfortable in all facets of the gift is important.
Communication and coordination are essential to make sure the overall tax, financial and personal outcomes are the best in the current tax regime. Keep in mind assistance from multiple advisors will be needed during this process. Trusted professional advisors can bring significant value in helping to select the best assets to transfer, for example, attorneys are essential to producing the legal documents needed to carry out the intention of the estate plan.
When planning one’s estate, don’t delay discussions about difficult inheritance and wealth transfer issues. A family willing to have an honest and open discussion now will avoid scorched relationships and negative financial impact later.
E. Patricia Chantleris a tax partner with Sensiba San Filippo LLP, and heads the firm’s Estate and Trust Group, specializing in tax planning and compliance needs of closely held businesses and their owners and families.
Wonsun Willeyis a tax partner with Sensiba San Filippo LLP, working primarily with owners of closely-held businesses. As a part of the firm’s Estate and Trust Group practice she also works with high net worth clients and their families.
About Sensiba San Filippo LLP
Sensiba San Filippo (SSF) is one of the largest Northern California based CPA and Business consulting firms. To learn more, please visit http://www.ssfllp.com/