The Family-Owned Business Interest Deduction: Pending Changes in Tax Law and Recent Court Rulings
Owners of family businesses, including farms, are at a disadvantage when it comes to tax planning. Many of the deductions available for current income do not apply to smaller businesses, which lack the liquidity for larger, long-range investments. Their focus is on day-to-day operations and more short-range planning, often at the expense of critical planning components like who will own and run the business next. Business owners need to know that nothing happens automatically except confusion and cost. Here’s a summary of the current situation.
Current federal tax law provides each individual with a $5,000,000 lifetime exemption from their taxable estate. It also provides that a married couple can intentionally combine their amounts through a “portability” feature. There are many reasons to be cautious about depending on the portability feature, which needs to be reviewed on an individual basis; but there are two reasons to be nervous about depending on the $5,000,000 exemption at all. First, your business assets are combined with other personal assets to arrive at the total estate value (with some adjustments) that increase it. It is surprisingly easy to be above the $5,000,000 threshold. Second, and most important, is that the whole thing changes at the end of this year unless Congress acts to extend it, going back to a $1,000,00 exemption. Best wisdom is that even if Congress extends the current level, estate tax laws will be completely rewritten during the next Congress.
Recent Tax Court rulings have upheld specific planning strategies, which can lock in the current exemption amount. Although it is good to know the IRS will work with you to keep your business intact, you will need to implement them before the current law changes.
Pending legislation with the working title, Family Farm and Small Business Tax Relief Act of 2012 (H.R.6271), would provide substantial relief to farm and business owners. If enacted, it would improve on the old Qualified Family-Owned Business Interest (QFOBI) exemption, which was repealed effective in 2004–2012. Under the proposed legislation, qualifying farms and businesses would not have their values included in estate tax calculations provided certain conditions were met. This late in a congressional year and during an election period, this bill is probably politically motivated but does give owners and their advisors some insight into how Congress may rewrite the tax laws in the coming year.
State tax laws like those in Tennessee can make a big difference, which is too often not considered. Tennessee is phasing out its inheritance tax laws, but until then, the state amounts are considerably below the federal level. The current exemption amount is $1,000,000, increasing to $1,250,000 in 2013, and incrementally thereafter until disappearing altogether in 2016.
Seek planning with your business succession strategy. Farm and small business owners, more than any other group, need to be proactive and intentional in their planning if they want to pass their business on to the next generation or sell it at a good price.
David W. Hayes is a Certified Financial Planner™ and IRS Enrolled Agent. This article is not a solicitation for business and is not intended to replace advice provided by Certified Public Accountants, Attorneys at Law, or other professionals. IRS Circular 230 requires that you be informed that any statements contained herein are not intended or written to be used, and cannot be used, by you or any other taxpayer, for the purpose of avoiding any penalties that may be imposed by federal tax law.