Family-Owned Business Deduction Chapter 42 Tools & Techniques of Estate Planning Copyright 2011, The National Underwriter Company1 What Is The Qualified

Family-Owned Business Deduction

Chapter 42Tools & Techniques of

Estate Planning

Copyright 2011, The National Underwriter Company 1

What Is The Qualified Family-Owned Business (QFOB) Deduction?

• The deduction has been repealed from 2004 to 2009 as the estate tax exemption equivalent increased above $1,300,000– The estate tax is repealed for one year in 2010

• The QFOB deduction will return along with the estate tax in 2011

• The QFOB deduction applies only to the federal estate tax



Estate Planning


• The deduction is available for up to $675,000 of qualified family owned business interests

• If the deduction is taken, the estate tax unified credit exemption equivalent is equal to the lesser of– The regular unified credit exemption equivalent, or– $1,300,000 minus the deduction

• The deduction is subject to recapture if the qualified heirs dispose of the interest or fail to materially participate in the business within 10 years after decedent’s death

What Is The QFOB Deduction? (cont’d)



Estate Planning


• When a substantial portion of the estate will consist of an interest in a family-owned business, and

• When the decedent or decedent’s family has materially participated in the business for five of the eight years preceding decedent’s death, and

• When the intention is to pass the business on to “qualified heirs” who will continue to operate it for 10 years following the decedent’s death

When Is Use Of The QFOB Deduction Appropriate?



Estate Planning


• Decedent must die in 1998-2003 or after 2012

• Decedent must have been a U.S. citizen or resident at death

• The executor must elect the application of the IRC Section 2057 QFOB deduction with the estate tax return

• Value of all qualified business interests, plus certain gifts made of such interests, must exceed 50% of the adjusted gross estate

What Are The Requirements?



Estate Planning


• A “qualified family owned business” is defined as either– a proprietorship, or

– an interest in an entity carrying on a trade or business

• In the case of a trade or business– 50% of the entity must be owned by the decedent and the

decedent’s family, or– 70% by two families or 90% by three families

• For the 70% and 90% tests, the decedent and the decedent’s family must own at least 30% of that entity

– The decedent’s family must have materially participated in the business

– Interests held by entities, including trusts, are subject to special attribution rules

What Are The Requirements? (cont’d)



Estate Planning


• A “qualified family owned business interest” does not include:– A business whose principal place of business is outside the U.S.– Any business whose stock or securities was readily tradable

within three years of decedent’s death– Any business with more than 35% of its adjusted gross income

from personal holding company income in the tax year of decedent’s death

– That portion of a business interest attributable to assets which produce personal holding company income (domestic or foreign)

– That portion of a business interest attributable to excess working capital




Estate Planning


• The QFOB interest must pass to a “qualified heir” which includes:– members of decedent’s family, and/or– an individual employed by the trade or business for at least 10 years

prior to the decedent’s death

• Recapture events to avoid within 10 years after decedent’s death but before the death of qualified heirs:– failure of an heir to participate in the business for at least 5 years out

of any 8 year period,– loss of U.S. citizenship by an heir, or– disposition of the business, other than to a family member or through

a qualified conservation contribution




Estate Planning


• Charles and his two children are the only shareholders of Nuts-4-U, Inc.

• At Charles’ death in 2003, his gross estate equaled $1.8 million

• Charles left his interest in Nuts-4-U, Inc. valued at $1.4 million to his children

• Charles had previously made annual exclusion gifts of Nuts-4-U, Inc. stock valued at $40,000 to his children

• At his death, Charles owed $60,000 on a mortgage and had $12,000 of other debt

How It Is Done – An Example



Estate Planning


Adjustments To Business ValueValue of Qualified Family Owned Business Interest $1,400,000

Plus: Gifted Business Interests 40,000

Less: Total Debts ($72,000)

Subtract from Total Debts (Line 3):

Residence debt to extent deductible under IRC $60,000

Qualified educational/medical expense debt 0

Other debts ($10,000 cap) 10,000 70,000

Total Debt Adjustment (Line 3 – Items in 4) (2,000)

Adjusted Value of Qualified Family Owned Business Interest

$1,438,000

How It Is Done – An Example (cont’d)



Estate Planning


Gross Estate For Qualified Family Owned Business Purposes

Gross Estate (including business) $1,800,000

Less: Usual Deductions (debts, administration, etc.) (100,000)

Adjusted Assets $1,700,000

Plus Gifts:

Gifted business interests $40,000

Gifts to spouse within 10 years of death 0

Non-business gifts over $10,000 within 3 years of death 0 40,000

Gross Estate for Qualified Family Owned Business Purposes $1,740,000




Estate Planning


Calculating Eligibility For The Deduction50% of Gross Estate (from Figure 42.2)

(if less than next line, estate is eligible)

$870,000

Adjusted Qualified Family Owned Business Interest (from Figure 42.1) $1,438,000

Maximum Deduction 675,000

Actual Deduction (lesser of Adjusted Qualified Family Owned Business Interest or Maximum Deduction amount)

675,000




Estate Planning


• Decedent’s taxable estate is reduced by the qualified family owned business interest deduction

• Benefit of deduction is generally recaptured if within 10 years after decedent’s death:

– qualified heirs dispose of the interest, or

– fail to materially participate in the business

Tax Implications



Estate Planning


• A surviving spouse’s interest, whether community property or separate property, is included in the calculation for determining the percentage of the business owned by the decedent

• All interests owned by the decedent’s family members are included in the 50% ownership test

Issues In Community Property States

Documents

Family-Owned Business Deduction Chapter 42 Tools & Techniques of Estate Planning Copyright 2011, The National Underwriter Company1 What Is The Qualified