Taking Control

As a small-business owner, you fight for every advantage to find ways to save money and earn profit. Cutting costs and leveraging your time efficiently can be the difference between a good year and a great year. When facing these everyday challenges, you may not take the time to address a long-term issue—estate planning. However, if you look ahead and plan your estate carefully, your family and business will benefit.

Estate tax

Currently, the estate tax is a graduated rate based on an estate's size and caps at 46 percent. Recent proposals in Congress have sought to eliminate the estate tax, but each one has failed when it was brought up for a vote. In fact, many of the wealthiest families in the U.S. have lobbied against repeal, making reform or repeal more difficult.

With the recent changes in Congress, the prospect of estate tax repeal is all but dead for at least the near future. The previous Congress was unable to make many of the provisions of the current code permanent, and several will expire in 2010. This makes estate planning more difficult than ever because many provisions may expire in as little as four years. If no reform measures are taken, tax laws could revert to pre-2001 rates and roll back any and all tax-planning advantages implemented during the past six years.

Estate planning

I do not recommend waiting until the estate tax issue is clarified in Congress to start your income and estate tax planning. An owner's unfortunate and untimely death can wreak havoc on a small business, leaving heirs in a state of confusion and needing money to settle the estate and pay taxes and outstanding liabilities. There are many opportunities to implement a secure planning foundation that will remain constant with any tax law changes.

In the broadest sense, estate planning is the accumulation, conservation and distribution of wealth in a manner that most efficiently and effectively accomplishes your objectives. An alternative definition, emphasizing the "planning" aspect, is that estate planning is a goal-oriented activity that uses tax-minimization tools and techniques, such as trusts, family limited partnerships and charitable planning, to provide the greatest possible financial security for individuals and their beneficiaries. Regardless of which definition is used, it is obvious estate planning is a key element of overall financial planning.

The best estate planning is controlled by an estate's owner and various financial advisers. Such people use various methods to reduce taxes and other causes of estate erosion and employ numerous tax and nontax tools and techniques to accomplish their objectives.

The problems

Before formulating an estate plan, you should know what problems you may face.

One problem is lack of liquidity. Test to see whether there are enough assets in your estate that quickly and inexpensively can be turned into cash to meet tax demands and other estate settlement costs. Identify the specific source(s) from which the estate will pay long-term care costs; funeral expenses; current and long-term bills and debts; unpaid income taxes; attorney's, accountant's and appraiser's fees; federal and state death taxes; and additional costs of estate administration.

A lack of liquidity is extremely serious because it often results in a forced sale at pennies on the dollar of the business or other important assets. Sacrifice sales of assets not only result in a disproportionately large loss of income but sometimes in devastating psychological trauma that emotionally cripples survivors, partners and employees.

Another problem is improper disposition of assets. Check various dispositive instruments, such as life insurance policies, wills, trusts, joint bank accounts, pension plans and other employee benefit plans to see whether assets are going to the wrong person at the wrong time or in the wrong manner. For instance, it would be inappropriate to put a high-powered sports car in the hands of a child. Yet hundreds of thousands of dollars worth of assets often are left outright to beneficiaries who are unwilling or are legally and/or intellectually or emotionally unable to manage them properly. An incompetent person and money are soon parted.

Inadequate income or capital poses another challenge. It is essential there are adequate income sources or sufficient capital to provide for retirement, the family following a death or permanent disability. For example, loss of income because of a disability often is coupled with massive financial drain. Both problems can be compounded by the inadequate management of currently owned assets. Together, these forces tend to diminish net worth with frightening speed.

Asset values destabilized and not maximized also can be a problem. Compare the value and marketability of business assets before and after various types of changes that occur during the life cycle of your business. For instance, will your business be worth the same (in terms of income-producing ability or financial net worth) after your death, disability or divorce?

Other challenges are a lack of a backup management team, failure of heirs to note a change in consumer preferences, or product or equipment obsolescence that may result in a rapid decline of the value of a business. Do you have a buy-sell agreement? Is it in writing? Does the price in that agreement reflect the current worth of the business? Is the agreement funded adequately with life insurance so your family's fortune is not dependent on the business? Is a life insurance policy worth as much to your family if it is paid to your estate instead of to a named beneficiary (perhaps because the primary beneficiary died and there was no secondary beneficiary named)? Are assets needlessly exposed to the claims of creditors?

Check to see what must be done to stabilize and maximize the value of the business and other assets by completely reviewing all necessary documents and plans.

You also may face excessive taxes and transfer costs. Are you paying unreasonably high income taxes? Is there an opportunity to reduce or defer income tax? Often, through various commonly used estate-planning tools or techniques, many thousands of dollars of income taxes and transfer taxes can be saved within a family unit.

Finally, you must address what may be the most important and difficult of all estate-planning problems many business owners face—special needs problems. Special needs problems include a spouse who cannot or will not handle money, property or a family business. Such problems also may include the care of a dependent who is physically, emotionally or intellectually handicapped or mentally disturbed. Consider the importance of providing proper financial support for exceptionally gifted children. Special needs also include the desire to provide meaningful financial support to schools, churches, synagogues, mosques, or other institutions and charities.

Taking steps

After addressing potential problems, you can begin the estate-planning process. There are seven key steps in the process designed to measure and prioritize, giving first preference to needs or problems you believe are most important. You should:

1. Gather comprehensive and accurate data about all aspects of the estate, including goals and desires.
2. Categorize data into general problem areas, such as the major areas previously described.
3. Estimate transfer costs and other liquidity needs. This amount generally is the sum of cash bequests in a will plus funeral and administrative expenses, debts and taxes, the state death tax and net federal estate tax.
4. Set priorities for problems, and prepare alternative solutions for each.
5. Together with other advisers, formulate an overall plan and determine an implementation procedure. Decide which parties are responsible for each task, and establish a timetable for action.
6. Test and implement the plan. Planning software can illustrate liquidity needs and tax liabilities.
7. Review the plan regularly. Because tax laws continue to change, updating your plan is absolutely necessary.

The documents

An estate plan directs how wealth will be assembled and distributed during life or upon death. The plan itself is useless unless the documents that implement the plan have been drafted appropriately. The documents should direct personal representatives, fiduciaries and beneficiaries through the process to ensure the successful distribution of wealth. These directions must comply with state laws and, most important, clearly should state your intentions. You should read and review all these documents carefully and understand every component before executing and signing them.

Because these documents necessarily involve compliance with state law, they should be prepared by an attorney who specializes in estate planning. Often, mail-order do-it-yourself kits and software packages are available at tempting prices; however, only with simple estate plans will these products be adequate. Moreover, if a simple plan is all that is required, an attorney still can be retained for a minimal fee.

The documents necessary for an estate plan include the following:

• An asset and personal records inventory. Perhaps the most important document a family will need after a person's death or incapacity is a written record listing the significant pieces of personal property and location of important documents (such as deeds, wills, trusts, insurance policies, employment records, tax records, etc.).
• A letter briefing the executor. Although a will should be clear and effectively dispose of a person's property, planners and attorneys sometimes recommend a person also provide a letter instructing the executor. This letter should include instructions regarding the location of records and preferences for disposing of property. Quite often, a will provides general language regarding beneficiaries' shares with no specific instructions about how the shares will be funded or which specific properties are to be given to which beneficiaries.
• A will. Despite the obvious importance of a will, a recent Consumer Reports survey revealed more than seven out of 10 U.S. adults do not have a valid will. Do not let yourself be among the procrastinators.
• Trusts. Not everyone will find the need to create trusts. However, people who wish to make relatively sophisticated lifetime gifts or reduce probate will find living trusts to be an essential part of their plans. People who need marital deduction tax planning in their wills or must protect minor children probably will want to include testamentary trusts in their wills. Many small-business owners will find a trust can allow for the continuation of a business without major disruptions if drafted properly.
• Power of attorney. If a person desires to have another individual take some specified actions—such as management of a securities portfolio—in certain circumstances, a power of attorney clause should be considered.
• Living will. If a person wants to give advance notice to medical care providers of the person's wishes in the event the person should become terminally ill or permanently comatose, a living will is recommended.
• Specialized documents. More complex planning requires the use of more complex documents, such as Irrevocable Life Insurance Trusts, Grantor Retained Income Trusts, Grantor Retained Annuity Trusts, Charitable Remainder Uni-Trusts and Qualified Personal Residence Trusts. These variations of the traditional trust provide many options and the flexibility to discount the value of assets transferred into the trust, thereby reducing estate-transfer costs while retaining some control of the income or other aspects of the asset.

Make a commitment

The most important step when developing your estate plan is the next step you take toward starting. One step at a time often is more productive that waiting until all the documents are collected or the time is right for a review. Appoint an adviser to take charge if you do not have time to complete the process. Don't let your business or estate suffer because of a lack of time or commitment.

Brian Heckert is president of PENFlex Services Inc., a business consulting firm with offices in Nashville, Ill., and Peoria, Ill.

An estate tax history

"Great accumulations of wealth cannot be justified on the basis of personal and family security … Such inherited economic power is as inconsistent with the ideals of this generation as inherited political power was inconsistent with the ideals of the generation which established our government."
—Franklin D. Roosevelt

"The man of great wealth owes a particular obligation to the State because he derives special advantages from the mere existence of government."
—Theodore Roosevelt

1797: The first estate tax is enacted to help pay for naval rearmament. It requires only the purchase of federal stamps for wills and estates but is terminated four years later because the need for the revenues passes.

1862: A direct tax on inheritances is imposed during the Civil War ranging from 0.75 percent to 5 percent.

1864: The top rate is raised to 6 percent, but the tax is abolished July 14, 1870.

1898: An estate tax with a top rate of 15 percent on estates of more than $1 million is imposed to pay for the Spanish-American War—it is repealed on April 12, 1902.

Early 1900s: Estate taxes are developed to pay for World War I.

1906: President Theodore Roosevelt proposes a federal inheritance tax.

1916: The U.S.'s fourth version of the estate tax is enacted, and a top rate of 10 percent on estates of more than $5 million is used.

1917: The estate tax is raised to 25 percent; this rate applies only to estates of more than $10 million.

1926: The top rate drops to 20 percent.

1929: The Great Depression hits the U.S., causing severe tax revenue shortfalls and a need to increase the treasury. Facing a budget crisis during the Great Depression, Congress raises the top estate tax rate to 70 percent for fortunes more than $50 million ($666 million in 2007 dollars).

1934: President Franklin D. Roosevelt raises the top rate to 60 percent.

1935: President Franklin D. Roosevelt raises the top rate to 70 percent. The same bill increases the top income tax rate to 75 percent and also increases corporate taxes. Altogether, the law raises just $250 million annually.

1936: The estate tax provides a full 11 percent of federal revenue. Until 2001, the estate tax remains essentially unchanged apart from rate adjustments and periodic increases in the amount of money exempt from tax.

Current: A graduated rate is in place based on an estate's size and caps at 46 percent.