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FIRMS’ OWNERS NEED PLAN TO AVOID FEDERAL ESTATE TAX

SHARE FIRMS’ OWNERS NEED PLAN TO AVOID FEDERAL ESTATE TAX

If a small-business owner isn't careful, Uncle Sam could inherit the family company.

More than 80 percent of all U.S. businesses - from mom-and-pop outfits to multinational corporations - are family owned. And many of them will face a transition soon.A staggering $7 trillion to $10 trillion, much of it in business assets, will be transferred to the younger generation during the next 15 years.

But that doesn't mean the kids will take over all those businesses.

History shows that the second generation takes over just 30 percent of family run firms. The rest disappear or are sold to outsiders.

Family business owners need a succession plan to protect against the peril that often pulls the plug on family ownership: the federal estate tax.

With rates reaching 55 percent for estates of more than $3 million, some businesses must be sold, often at bargain-basement prices, to pay the tax bill.

One tool for transferring ownership of a closely held business while retaining income or control and reducing federal estate taxes is the grantor-retained annuity trust (GRAT).

With a GRAT, a business owner transfers company stock or other income-producing assets to an irrevocable trust that pays the owner a fixed income for a set number of years.

At the end of that time - say, three, five or 10 years - the property goes to the trust's beneficiaries, perhaps the owner's children.

The beauty of a GRAT is that the value of the assets for gift-tax purposes is fair market value at the time of the gift minus the present value of the income that will be paid out to the grant - or over the term of the trust.

The value may be further discounted if, for example, the shares represent a minority interest or there are restrictions on their sale.

Thus, if the trust is engineered carefully, a GRAT can remove a sizable chunk of the business's value (and any future appreciation) from the owner's estate absolutely free of gift and estate taxes.

If the owner dies before the end of the trust term, however, the assets go back into his or her estate.

For more information on GRATs and other topics related to succession planning, read "Passing the Torch: Succession, Retirement, & Estate Planning in Family-Owned Businesses" (McGraw-Hill), by Mike Cohn, a Phoenix-based family business consultant.