Estate Planning Blog Articles

Estate & Business Planning Law Firm Serving the Providence & Cranston, RI Areas

What Is Family Business Succession Planning?

Many family-owned businesses have had to scramble to maintain ownership, when owners or heirs were struck by COVID-19. Lacking a succession plan may have led to disastrous results, or at best, less than optimal corporate structures and large tax bills. This difficult lesson is a wake-up call, says the article “Succession Planning for the Family-Owned Business—Keepin’ it ‘All in the Family’” from Bloomberg Tax.

Another factor putting family-owned businesses at risk is divorce. Contemplating the best way to transfer ownership to the next generation requires a candid examination of family dynamics and acknowledgment of outsiders (i.e., in-laws) and the possibility of divorce.

Before documents can be created, a number of issues need to be discussed:

Transfer timing. When will the ownership of the business transfer to the next generation? There are some who use life-events as prompts: births, marriages and/or the death of the owners.

How will the transfer take place? Corporate structures and estate planning tools provide many options limited only by the tax liabilities and wishes of the family. Be wary, since each decision for the structure may have unintended consequences. Short and long-term strategic planning is needed.

To whom will the business be transferred? Who will receive an ownership interest and what will be the rights of ownership? Will there be different levels of ownership, and will those levels depend upon the level of activity in the business? Will percentages be used, or shares, or another form?

In drafting a succession plan, it is wise to assume that the future owners will either marry or divorce—perhaps multiple times. The succession plan should address these issues to prevent an ex-spouse from becoming a shareholder, whose interest in the business needs to be bought out.

The operating agreement/partnership agreement should require all future owners to enter into a prenuptial agreement before marriage specifically excluding their interest in the family business from being distributed, valued, or deemed marital property subject to distribution, if there is a divorce.

An owner may even exact a penalty for a subsequent owner who fails to enter into a prenup prior to a marriage. The same corporate document should specifically bar an owner’s spouse from receiving an ownership interest under any circumstance.

A prenup is intended to remove the future value of the owner’s interest from the marital asset pool. This typically requires the owner to buy-out the future spouse’s legal claim to future value. This could be a costly issue, since the value of the future ownership interest cannot be predicted at the time of the marriage.

Many different strategies can be used to develop a succession plan that ideally works alongside the business owner’s estate plan. These are used to ensure that the business remains in the family and the family interests are protected.

Reference: Bloomberg Tax (April 5,2021) “Succession Planning for the Family-Owned Business—Keepin’ it ‘All in the Family’”

Does My Family have to Pay My Credit Cards when I Die?

Market Realist’s recent article entitled “What Happens to Credit Card Debt When You Die?” says that the short answer is that the deceased’s estate pays off any credit card debt they have left behind. Credit card debt and other debts can pass on to others in some cases, which is a big reason why estate planning is so important.

When a person dies, their assets are frozen until his or her will is verified, their debts are settled and their beneficiaries are identified in the probate process.

Then, the state will order that the deceased’s remaining assets (such as leftover cash and property with cash value) be used to pay off the credit card debt. However, retirement accounts, eligible brokerage accounts, and life insurance payouts are usually protected from this debt reconciliation. Once the debts are settled, the beneficiaries get their inheritance.

The debts are paid off until they’re all settled, or until the estate runs out of money. Unsecured debts, like credit cards, are usually paid off after secured debts, administrative fees and attorney fees.

There are some circumstances in which another person is legally obligated to pay the deceased’s debt.

Typically, no one is legally required to pay off a deceased individual’s debts, but there are some exceptions:

  • Co-signers must pay loans
  • Joint account holders must pay the debt on credit card accounts
  • Spouses have to pay particular types of debt in some states; and
  • Executors of an estate must pay outstanding bills out of property jointly owned by the surviving and deceased spouses in some states.

In addition, surviving spouses may be required to use community property to pay their deceased spouse’s debt in certain states.

The community property states are Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington, and Wisconsin. Alaska would also be included in this list, if a special agreement is in place.

If there was no joint account, co-signer, or other exception, only the estate of the deceased person owes the debt.

Reference: Market Realist (Feb. 11, 2021) “What Happens to Credit Card Debt When You Die?”

What States Make You Pay an Inheritance Tax?

Let’s start with defining “inheritance tax.” The answer depends on the laws of each state, so you’ll need to speak with an estate planning attorney to learn exactly how your inheritance will be taxed, says the article “States with Inheritance Tax” from yahoo! finance. There are six states that still have inheritance taxes: Iowa, Kentucky, Nebraska, New Jersey, Maryland and Pennsylvania.

In Iowa, you’ll need to pay an inheritance tax within nine months after the person dies, and the amount will depend upon how you are related to the decedent.

In Kentucky, spouse, parents, children, siblings and half-siblings do not have to pay inheritance taxes. Others need to act within 18 months after death but may be eligible for a 5% discount, if they make the payment within 9 months.

Timeframes are different county-by-county in Maryland, and the Registrar of Wills of the county where the decedent lived, or owned property determines when the taxes are due.

Only a spouse is exempt from inheritance taxes in Nebraska, and it has to be paid with a year of the decedent’s passing.

New Jersey gets very complicated, with a large number of people being exempted, as well as qualified religious institutions and charitable organizations.

In Pennsylvania, rates range from 4.5% to 15%, depending upon the relationship to the decedent. There’s a 5% discount if the tax is paid within three months of the death, otherwise the tax must be paid within nine months of the death.

As you can tell, there are many variations, from who is exempt to how much is paid. Pennsylvania exempts transfers to spouses and charities, but also to children under 21 years old. If one sibling is 20 and the other is 22, the older sibling would have to pay inheritance tax, but the younger sibling does not.

There’s also a difference as to which property is subject to inheritance taxes. In Nebraska, the first $40,000 inherited is exempt. Pennsylvania exempts certain transfers of farmland and agricultural property. All six exempt life insurance proceeds when they are paid to a named beneficiary, but if the policies are paid to the estate in Iowa, the proceeds are subject to inheritance tax.

Note that an inheritance tax is different than an estate tax. Both taxes are paid upon death, but the difference is in who pays the tax. For an inheritance tax, the tax is paid by heirs and the tax rate is determined by the beneficiary’s relationship to the deceased.

Estate tax is paid by the estate itself before any assets are distributed to beneficiaries. Estate taxes are the same, regardless of who the heirs are.

There are twelve states and the District of Columbia (Washington D.C.) that have their own estate taxes (in addition to the federal estate tax). Note that Maryland has an inheritance, state and federal estate taxes. The rest of the states with an estate tax are Connecticut, Hawaii, Illinois, Maine, Massachusetts, Minnesota, New York, Oregon, Rhode Island, Washington and Vermont.

The large variations on estate and inheritance taxes are another reason why it is so important to work with an experienced estate planning lawyer who knows the estate laws in your state.

Reference: yahoo! finance (Jan. 6, 2021) “States with Inheritance Tax”

Some States Have No Estate or Inheritance Taxes

The District of Columbia already moved to reduce its exemption from $5.67 million in 2020 to $4 million for individuals who die on or after Jan. 1, 2021. A resident with a taxable estate of $10 million living in the District of Columbia will owe nearly $1 million in state estate tax, says the article “State Death Tax Hikes Loom: Where Not To Die In 2021” from Forbes. It won’t be the last change in state death taxes.

Seventeen states and D.C. levy their own inheritance or estate taxes in addition to the federal estate tax, which as of this writing is so high that it effects very few Americans. In 2021, the federal estate tax exemption is $11.7 million per person. In 2026, it will drop back to $5 million per person, with adjustments for inflation. However, that is only if nothing changes.

President Joseph Biden has already called for the federal estate tax to return to the 2009 level of $3.5 million per person. The increased tax revenue purportedly would be used to pay for the costs of fighting the “pandemic” and the “infrastructure improvements” he plans, but many believe such a move would potentially destroy family businesses, farms and ranches that drive and feed the economy in the first place. If that were not troubling enough, President Biden has threatened to eliminate the step up in basis on appreciated assets at death.

This change at the federal level is likely to push changes at the state level. States that don’t have a death tax may look at adding one as a means of increasing revenue, meaning that tax planning as a part of estate planning will become important in the near future.

States with high estate tax exemptions could reduce their state exemptions to the federal exemption, adding to the state’s income and making things simpler. Right now, there is a disconnect between the federal and the state tax exemptions, which leads to considerable confusion.

Five states have made changes in 2021, in a variety of forms. Vermont has increased the estate tax exemption from $4.25 million in 2020 to $5 million in 2021, after sitting at $2.75 million from 2011 to 2019.

Connecticut’s estate tax exemption had been $2 million for more than ten years, but in 2021 it will be $7.1 million. Connecticut has many millionaires that the state does not wish to scare away, so the Nutmeg state is keeping a $15 million cap, which would be the tax due on an estate of about $129 million.

Three states increased their exemptions because of inflation. Maine has slightly increased its exemption because of inflation to $5.9 million, up from $5.8 million in 2020. Rhode Island is at $1,595.156 in 2021, up from $1,579,922 in 2020. In New York, the exemption amount increased to $5.93 million in 2021, from $5.85 million in 2020.

The overall trend in the recent past had been towards reducing or eliminating state estate taxes. In 2018, New Jersey dropped the estate tax, but kept an inheritance tax. In 2019, Maryland added a portability provision to its estate tax, so a surviving spouse may carry over the unused predeceased spouse’s exemption amount. Most states do not have a portability provision.

Another way to grab revenue is targeting the richest estate with rate hikes, which is what Hawaii did. As of January 1, 2020, Hawaii boosted its state estate tax on estates valued at more than $10 million to 20%.

If you live in or plan to move to a state where there are state death taxes, talk with your estate planner to create a flexible estate plan that will address the current and future changes in the federal or state exemptions. Some strategies could include the use of disclaimer trusts or other estate planning techniques. While you’re at it, keep an eye on the state’s legislature for what they’re planning.

Reference: Forbes (Jan. 15, 2021) “State Death Tax Hikes Loom: Where Not To Die In 2021”

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