Business Owners – Don’t Get Taxed Out of Your Fortune!

The new year has just started, and the clock is ticking for private business owners like you to make sure that you have planned properly to protect your hard-earned wealth. At the end of 2025, the current estate tax rules and exemptions are set to expire, and if you don’t begin planning now, you may find yourself short of the gifting levels you have been hoping for and subject your estate to significant estate taxes which can be avoided with proper planning.

For those of you busy running a successful business, staying up to speed on the latest changes to estate tax rules and exemptions may not be one of your top priorities.  An article by Moss Adams published on November 9, 2023 highlights one of the more important changes recently approved.  Specifically, the article explains that “The increased estate and gift tax exemption, which is currently $12.92 million per person and increased to $13.61 million per person for 2024, is set to sunset at the end of 2025. As a result, the exemption will drop back to the prior Tax Cuts and Jobs Act (TCJA) level of $5 million, adjusted for inflation. The current maximum 40% gift and estate tax rate is also set to increase in 2026 to 45%.

The consequences are significant – for example, a husband and spouse family-owned company worth $25 million dollars would incur no estate tax if proper planning was accomplished in 2024.  In 2026 and thereafter, their estate upon death or during life would be reduced by $6,750,000, netting $18,250,000 instead of $25,000,000.

There are several strategies worth consideration to minimize estate and capital gains taxes.  If you have been considering selling your company, you might consider a sale in 2024 or 2025 and transferring proceeds under the higher estate and gift tax exclusion.  If you want to consider a sale in 2024, the time to start is now to get your company in shape to maximize its value and explore market options.  Many business owners underestimate the steps needed to prepare for sale and increase the likelihood that they will attract the right buyers and get the full value that their business is worth.

There are also several other strategies that can be utilized to minimize the estate and gift tax changes and maximize the value of the assets passed to your heirs. These changes can create a unique planning opportunity for high-net-worth families and individuals whose estates are subject to transfer taxes. Proactively planning before the 2025 year-end sunset may help reduce future estate, gift, and generation-skipping transfer taxes.  It is important for business owners to evaluate planning options as soon as possible, given that the estate planning process can be complex and time-consuming, and an 18-month process is not atypical.

Use of a Self-Cancelling Note to Reduce Estate Tax

As a further planning strategy, a Self-Cancelling Note (SCIN) can be used in estate planning, for an owner to sell your business or other assets to your children or other family members (or to a trust for their benefit) in exchange for an interest-bearing installment note. If the purchase price and interest rate are reasonable, there’s no taxable gift involved. So, an owner can take advantage of a SCIN without having to use up any of their annual gift tax exclusions or lifetime gift tax exemption.

Utilizing a SCIN, if an owner dies before the note matures, the outstanding principal is excluded from their estate. This allows the owner to transfer significant wealth to children or other family members tax-free. And any appreciation in the asset’s value after the sale is also excluded from your estate.

A SCIN offers a variety of valuable tax benefits and can be used in conjunction with various types of trusts which can avoid the estate tax and also state inheritance taxes and lengthy probate delays.

Avoiding Taxable Gain on the Sale of Stock

Section 1202 of the Internal Revenue Code allows individuals to avoid paying taxes on up to 100% of the taxable gain recognized on the sale of qualified small business corporation stock (sometimes referred to as QSBS). And even though it’s framed as a small business tax incentive, a business can be quite large and still qualify as a “small business.”

The gain exclusion is available for stock issued after Aug. 10, 1993, and applies to the greater of $10 million or 10 times the aggregate adjusted basis of the stock at the time of the issuance. Section 1202 can create an effective tax rate savings of up to 23.8% for federal income tax purposes under current law.

Don’t Delay Taking Action

Estate planning and the preparation and successful sale of a business both take many months.  Especially now, when there is a limited amount of time before the estate and gift tax exemption reverts to its previous, less favorable levels, early action is advisable.  The amount of time needed cannot be estimated until you both assess your situation and goals with your tax advisor and start the process to prepare for a sale of your business by first establishing its readiness. If you are not sure whether you are ready to sell or wish to pursue more detailed tax planning, consider starting with an experienced CEO advisor from Newport, LLC.  Our partners all have decades of experience helping privately owned businesses accelerate their growth, de-risk their business and realize their value, and, together with your tax and legal advisors, will make sure you don’t miss out on the potentially negative shifts that the revised estate and gift tax rules could mean to the future of your gifting goals.

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