Protect Family Businesses From The Estate

One of the most common tax problems faced by AED members is the transition of a family-owned business from one generation to the next. It becomes particularly difficult for businesses that are large enough to exceed the estate and gift tax exclusions, especially because construction equipment distributors and manufacturers are so capital-intensive.

As Congress debates comprehensive tax reform, there is a real chance that the estate and gift tax will be eliminated.

Midmarket family-owned businesses often have decades of history providing stable and prosperous jobs to their communities. It would seem society would have a vested interest in protecting the continuity of these businesses over family generations.

Bruce McFee TAX - body

Unfortunately, the estate tax can disturb the continuation of a family business, whereas its impact on a publicly traded company can be quite different. In a family business, the management often owns all the stock, whereas in a public company the stock can be owned by other entities that hire the management. When a key person dies or leaves a publicly traded company, it is easy for those individuals to sell the shares on the open market. The company gets a new owner, cash is provided to the seller that can fund any estate or capital gains tax, and the original capital can remain in the business.

However, the estate tax makes it difficult for family-held businesses because of the difficulty of finding an outside buyer for a minor portion of the shares. Regardless of whether the business transfer occurs by death or by an outright sale, it creates a taxable event that can send years of profits to the Internal Revenue Service (IRS). Yet the capital is needed to pay for facilities, equipment, inventory, trade receivables and the other things that support jobs and growth. At a minimum, the tax reduces a firm’s ability to re-invest or grow.

Even worse, the estate tax is set up as a windfall where it isn’t likely to be known when the taxable event will occur or how much tax might be involved. For example, it would make a considerable difference if the time frame were known to be 18 months versus 30 years.  Regarding a valuation, the IRS might adjust multiples depending on the point of time in the business cycle or assign an intangible value to things like a trade name or new innovative products. Without knowing when or how much an estate tax might be, planning can be extremely difficult for the family-owned business.

Another problem is that the capital needs of the business might change. For instance, the construction equipment industry needed to upgrade to Tier IV. It caused the inventory and trade receivables to be significantly higher, requiring a proportionate amount of additional owner equity to maintain the same business.

In more severe cases, the estate tax has forced the outright sale of family-owned businesses, often to a financial buyer that might have different goals for the business. The subsequent disruption often impacts long-time employees and in some cases, results in the business and jobs being moved out of the country.

In the event the estate tax repeal is taken out of the tax bill, there should be a special carve-out for family businesses. Germany already has this kind of provision for family-owned businesses.  While the cost of this carve-out would be much less than repeal of the entire estate tax, the benefits of continuing family-owned businesses is significant. You can help by contacting your congressional office to let them know your company’s importance to the community and why the federal estate and gift tax need to be repealed once and for all.


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