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ESTATE ADMINISTRATION FOR
CLOSELY HELD BUSINESS INTERESTS
ESTATE ADMINISTRATION FOR
Prepared by J. Randolph Robida, Attorney at Law
© December, 1998
J. Randolph Robida all rights reserved.
The following materials were presented at a seminar sponsored by the National Business Institute ("NBI") in Denver, Colorado, on January 20, 1999. The program, "Advanced Post-Mortem Planning and Probate in Colorado" was presented by attorneys, Randolph Robida and Steven Warden (of Wade Ash Woods Hill & Farley, PC, Denver, Colorado). The materials contained in this page are from the portion of the program delivered by Randy Robida. If you would like additional information about the issues discussed herein, related legal issues, or other seminars presented by Randy Robida or NBI, please contact our office or NBI.
Please Note: These materials should not be used as a substitute for professional advice where questions of interpretation should be addressed by a professional advisor. Please read the DISCLAIMER before continuing on this page.
ESTATE ADMINISTRATION FOR CLOSELY HELD BUSINESS INTERESTS
TABLE OF CONTENTS
PART A - Finding and Determining Assets
PART B - Valuing Assets
PART C - Closely Held Business Interests
If the decedent and his or her advisors engaged in thorough estate planning before death there should not be a need for and may not be much possibility of substantial post mortem planning. Thorough pre-death planning should cover at least the following issues:
2. Buy/Sell arrangements
3. Continued operation immediately following the owner's death
4. Valuation for probate and estate tax purposes, and
5. Family control issues
This outline deals largely with matters arising when the pre-death planning has been inadequate, or when changed circumstances make an otherwise adequate plan inadequate.
A. - FINDING AND DETERMINING ASSETS
A.1. It's not unusual for surviving family members to know very little about a decedent's business interest. If the decedent had an even somewhat complicated business interest it is rather easy for business operations to get out of hand quickly following his or her death. This may lead to substantial loss of value and/or income.
A.2. The first thing to keep in mind when dealing with an estate administration involving substantial business interests is that you are probably in for a lot of work. If the business does not have detailed legal and accounting records there will be even more work. Unfortunately in many small businesses poor legal and accounting records are the rule, rather than the exception.
A.3. The most obvious sources of information about a decedent's business interests are family members, other owners and employees. There are other potential sources of information which should be investigated as well.
A.3.(a). Tax returns may be one of the most valuable sources of information for locating and valuing business assets. Someone should review returns for the most recent three to five years for both the individual (Form 1040) and the business entity if the entity has a separate return (Forms 1120, 1120S and 1065).
A.3.(b). Some returns include a balance sheet. This may be a valuable source for locating assets. Even when there is not a balance sheet a careful review of income and expense items will often go a long way toward preparing a complete list of business assets.
A.3.(c). The return preparer's workpapers often contain valuable information may not be directly shown on the return.
A.4. Accountant or CPA. Most businesses engage the services of an accountant or CPA to prepare tax returns and/or financial statements. The accountant is often the primary source of asset information, especially if he or she prepares periodic financial statements or other financial documents in addition to annual tax returns. If the business does not use an outside accountant much of the same information may be available from the bookkeeper.
B. - VALUING ASSETS
B.1. If the estate will be required to file an estate tax return or if the assets of the estate are to be divided by value or percentages, the estate will need to hire a business valuation specialist to prepare an appraisal of the business and its assets.
B.1.(a). If the appraisal is for estate tax purposes, it is best to have the appraisal done by someone who has substantial experience in preparing estate tax valuations and who has earned the respect of the Internal Revenue Service. It is very likely that the estate will eventually find itself negotiating with the Service over the value of the business, and the reputation of your appraiser can have a significant impact on the outcome.
C. - CLOSELY HELD BUSINESS INTERESTS
C.1. The Family Owned Business
C.1.(a). A family owned business that has not been the subject of thorough pre-death estate planning can result in substantial estate administration problems. In addition to the complex legal and tax issues there are often enormously difficult emotional issues which must be addressed.
C.1.(b). Need for Quick Action. Many assets can be left alone for a short period following the death of the owner. A business is not one of those assets. Businesses usually requires quick action and daily attention.
C.1.(c). It may be appropriate to arrange a meeting of the interested parties as quickly as feasible to make sure that some system for the continued operation of the business is in place. Among other things it is important to establish who will be responsible for day-to-day operations.
C.1.(d). If the interested parties cannot agree on someone to handle business operations the attorney should consider an expedited hearing before the Probate Court to resolve the issue. Without quick action the value of the business may be substantially impaired, possibly resulting in claims against the P.R. and/or legal counsel.
C.1.(e). Even if a sale of the business is anticipated it is important that operations continue smoothly until the sale to avoid a loss in value.
C.1.(f). Both for informational purposes and to emphasize the difficulty of administering a family business the practitioner should know that there have been at least two groups of psychologists and/or psychiatrists in the Denver area who specialize solely in family business transfer issues.
C.2. Liquidity Issues
C.2.(a). If a closely held business interest comprises a substantial portion of the decedent's estate, liquidity issues may become extremely important. Many, if not most, closely held businesses consist largely of illiquid assets, including goodwill. In the case of a valuable but illiquid business it is possible that the estate tax on the value of the business will exceed the cash and other liquid assets available to pay the tax. This situation could lead to the forced sale of a family business built up over many years or even generations.
C.2.(b). Fortunately the Internal Revenue Code contains a number of provisions designed to assist the estate in dealing with this issue.
C.2.(b)(1). Section 2057-Family Owned Business Exclusion. The Taxpayer Relief Act of 1997 introduced Section 2033A to the Internal Revenue Code. Section 2033A created an exclusion from estate tax for the value of certain family owned business interests. The IRS Restructuring and Reform Act of 1998 amended Section 2033A and redesignated it as Section 2057. Under the amended provisions of Section 2057 an estate is allowed a deduction of up to $675,000 for the value of qualifying family owned businesses. This provision is effective for the estates of decedents dying after December 31, 1997. In order to qualify for the exclusion the value of the business interest must exceed 50% of the value of the gross estate. In addition the family owned business deduction may be recaptured if the beneficiaries fail to continue operating the business in a qualified fashion within ten years of the decedent's death. A qualified family owned business interest does not include a business which receives a substantial portion of its income through investment-type activities. This rule is intended to prevent taxpayers from taking advantage of the exclusion by "incorporating" their investment activities. In addition the decedent or a family member must have been actively engaged in the trade or business for the business to qualify.
C.2.(b)(2). Section 6166-Extension of Time for Payment. If the value of a closely held business exceeds 35% of the value of the adjusted gross estate the Executor may elect to pay all or part of the estate tax in from two to ten equal installments. The amount of tax which may be paid in installments is equal to that amount which bears the same ratio to the total tax as the value of the closely held business bears to the value of the adjusted gross estate. The first installment must be paid not more than five years after the tax would have otherwise been due and each succeeding installment must be paid on or before one year following the previous installment.
C.2.(b)(3). Both of the above provisions contain a number of complex rules and requirements and must be reviewed carefully.
C.3. Stock Redemptions
C.3.(a). If a substantial portion of the decedent's estate consists of stock in a closely held corporation it may be appropriate to convert the stock to cash which can be used to pay estate taxes by way of a stock redemption. If the corporation has sufficient liquid assets to redeem the stock the redemption procedure can resolve a number of potential problems.
C.3.(b). A stock redemption is essentially the purchase of the deceased shareholder's stock by the corporation. The redemption has the same effect on ownership percentages as a pro rata purchase of the deceased shareholder's stock by all of the other shareholders but is a substantially simpler procedure.
C.3.(c). In addition to providing cash to the estate a redemption can resolve potentially troublesome issues associated with a sale of closely held stock to third parties.
C.3.(d). The redemption procedure can work for other ownership interests, such as an interest in a limited liability company or partnership, as well as for stock.
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