More than a month has passed since the passage of the $1.3 trillion tax cut, with its centerpiece for entrepreneurs: the repeal of the estate tax. Yet as the dust settles, small-business owners and their accountants and attorneys discover that there's less to it than the headlines suggested. Entrepreneurs continue to be baffled about the new law's implications for estate planning.
At the heart of the confusion is the protracted timetable for the phase-out of the estate tax. It takes eight years, for example, for the top rate to fall to 45%, from 55%, and nine years for the exemption to rise to $3.5 million from $675,000. When outright repeal does take effect in 2010, it will last just 12 months. Current rates come back in 2011 unless Congress acts to retain the cuts. (For more details, see BW Online, 6/13/01, "The Accountants' Employment Act")
With long-term policies so vague, how should entrepreneurs adjust their estate planning? BusinessWeek Small Business Editor Naween Mangi recently spoke with New York attorney Herbert B. Fixler, co-chair of the estate-planning and administration division of Hall Dickler Kent Goldstein and Wood LLP. Following are edited excerpts of their conversation:
Q: What advice are you giving clients to deal with the estate-tax reforms?
A: The first thing we tell them is that most provisions are deferred far into the future. And there's a great deal of uncertainty as to whether or not these provisions will ever actually take effect. We never know when death will occur, but now the timing of death has enormous consequences. We're telling our clients that it's essential they build in as much flexibility into their estate plans as they can and to give their executors as much flexibility in decision making as they can.
Q: What estate-planning strategy should an older entrepreneur follow in light of the reforms?
A: They should plan with the idea that there will be an estate tax of some magnitude. Baby boomers are now 11 years from retiring, and there's going to be a huge burden on Social Security and Medicare. Unless the economy goes back to what it was before spring, 2000, the government is going to be looking for revenue, and the estate tax is going to be one place they can get it.
So older people will have to resort to taking dramatic steps, especially if they're the typical business owner who didn't plan while he was younger. For example, obtaining life insurance, even at an old age, can be a very effective way to allow for the business to be handed down without being decimated by a large tax bill.
Q: What about younger entrepreneurs?
A: I counsel clients at an early stage to transfer equity interests in the business into trusts for their children and heirs. The reason is: You have a much longer period in which to make the transition. You can use the annual gift-tax exemption annually. There are always ways to make sure you retain a good share of the income stream but perhaps not the equity.
Q: Studies show that most entrepreneurs do little or no formal estate planning. How big a mistake are they making?
A: It's a enormous mistake. We have seen so many businesses that failed -- not because the heirs can't pay the estate tax, but because of a failure to plan for that intergenerational transition. The successful entrepreneur doesn't want to tackle that issue because they usually don't trust people enough to take over the business. So the second generation is never allowed to sprout wings at all to run the business.
Q: Among those who do plan, what common mistakes do entrepreneurs make?
A: One of the most common mistakes is they attempt to retain control for too long. The key to successful planning is making sure that the financial security of the business owner is taken care of outside the business. So what happens is that the owner is still dependent on the business for income and financial security, and it's a rare client who will let go. That's why planning should occur early on, because it takes a long time to achieve financial security independent of the business.