Jack C. founded and developed a prosperous waste management firm in the South. While he is proud of his accomplishments, he knows that he can't stay at the helm forever. That's why he began shifting ownership of the company to his sons six years ago. Soon, two sons will own 52 percent of the company, while another son owns non-voting shares.
Shifting ownership to family members and even to outsiders will eventually reduce the taxes that Jack's estate will pay. Moreover, the value of a minority stake in a business tends to be worth much less than a majority share. Accountants and appraisers say that a 49 percent interest in a business can be worth 25 to 35 percent less than a 51 percent stake.
For years, many large businesses have been valuing shares on this basis. In 1993, the Internal Revenue Service (IRS) said that closely held family businesses also could do so.
When Jack dies, the savings on estate taxes could be substantial. The top rate on federal estate taxes is a whopping 55 percent. Anyone can leave $600,000 to heirs without incurring an estate tax, but from there the rate quickly soars, reaching 55 percent at $3 million. If a family must sell a business to pay an estate tax bill, the next generation loses an opportunity to continue the enterprise.
Family business owners hope that a Republican-dominated Congress will change the estate tax law. Last July, Sen. Robert Dole (R-Kan.) and Sen. David Pryor (D-Ark.), among others, introduced a bill that would make it easier to transfer small family-owned businesses.
The bill would exempt family businesses worth up to $1.5 million from federal estate taxes. Excess value would be taxed at not more than 27.5 percent. Separate proposals have been introduced to raise the estate tax exemption from $600,000 to $750,000.
Meanwhile, individuals who own property valued at well above $600,000 may benefit their families by giving away assets during their lifetime. The IRS allows individuals to give annual tax-free gifts worth up to $10,000 to anyone.
That's when the so-called minority discount begins to take effect. Tax advisors say that the value of a minority stake can be reduced by 30 percent or more of its face value.
Jack, who started by giving away a $10,000 stake in the waste company to each of his sons, can discount the shares by 30 percent under the 1993 IRS ruling. Thus, he can give each son a stake with a face value of $14,000, discount it by 30 percent to $9,800, and still remain under the annual limit.
The key is to start early and give away shares of the business rather than cash. "You make the gift tax-free, but from an estate tax standpoint, you are removing the value of the gift and all its future appreciation and income," said a lawyer who specializes in estate planning. So, a $10,000 share in the business in 1980 might grow to $100,000 in 20 years.
Some individuals are using limited partnerships to take advantage of the minority discount. For example, a physician placed his home, a farm, all his stocks, bonds and cash into a limited partnership where the doctor and his wife each own 45 percent and their children own 10 percent. As the years pass, the parents will continue to transfer shares in the partnership by changing the percentage figures on the partnership books.
When Jack becomes a minority shareholder in the company, he plans to move to a home office and surrender his position to one of his majority-interest sons. He will stay on the payroll as a consultant, especially for big-ticket capital expenditure decisions. "If they can't agree, then I become the tie-breaking vote," he said.