To avoid unnecessary taxes when transferring your home care business and estate to your beneficiaries, it’s important to understand tax laws and how to use them to your advantage. But before we jump into this discussion, we need to define “estate” first.
For federal tax purposes, an estate is everything you control at the time of your death–including life insurance proceeds and jointly-owned property. Federal and most state governments impose a tax if your estate exceeds the exempt amount during the year of your death (between one and three million currently). Obviously, you don’t want to pay more than necessary. Let’s see how.
First, make full use of the exemption amount. This exemption is also available to your spouse, and with proper planning, an estate between two and seven million may pass to your children without tax consequences, depending on current estate tax laws.
Second, the marital deduction can reduce or eliminate estate taxes. Provided your spouse is a U.S. citizen, you may in most cases pass your entire estate to your spouse without tax, as gifts or upon death, even if your estate is worth $50 billion! Sounds great, right? But there’s a trap here. When the surviving spouse dies, the only available deduction is the exemption amount. This means that the entire tax burden will normally fall upon the surviving children.
Let’s take the hypothetical example of Wayne and Connie Smith, a couple in their late thirties with two young children. They have personal property and investments totaling $700 thousand, $1.3 million equity in their house, twin life insurance policies for $1 million, and a home care business worth $5 million. Their total estate is valued at $9 million.
As explained above, there would be no tax when the first spouse died, as their initial estate plan was structured, but the estate would incur between one and three million after the second spouse passed on. The Smith’s exit planning advisor explained this but the couple was comfortable with the taxes as long as the surviving spouse was provided for. Imagine their surprise when their advisor explained they could do both!
First, their exit planning advisor recommended the joint asset tenancy be severed and each spouse acquire approximately $3.5 million in assets. The life insurance would be put in an irrevocable trust to keep the proceeds from being subject to estate taxes. Under current tax law, if death occurs within three years of this transfer, the proceeds would revert back to the decedent’s estate. This carries an important caveat: you MUST consult an experienced estate planning professional to avoid the “Reciprocal Trust Doctrine” trap.
After equalizing their estates, the Smiths created wills with trust provisions–living trusts work equally well for this. The result of their exit planning was to transfer, tax-free, as much of the estate as possible to their surviving children. Regardless of who passed first–a crucial planning point–the estate exemption amount prevailing would go into a trust for the survivor. The survivor would receive income for the rest of their life and have significant control over the trust. But for estate tax purposes, only the amount owned by the surviving spouse would be included in the estate upon their passing. Additionally, if the decedent owned assets over the exempt amount, the balance would go to the survivor via a provision in the will or trust that would qualify for the marital deduction.
As you can see, proper exit planning reduced or eliminated estate taxes for the Smiths–again, it depends on the year of death–because the surviving spouse’s estate consisted of well less than half the original estate. Their trusts also benefitted the surviving children, with the remaining amounts being distributed at predetermined ages.
Estate planning is a lifetime process that changes as your lifestyle and exit planning objectives change. And your degree of planning will determine the price your family will pay long after you are gone. Thorough estate planning will help you accomplish these goals:
*providing family income after your death
*minimizing or eliminating estate taxes
*fueling estate growth outside your home care business interests
*providing a fair, if not necessarily equal distribution of your estate before and after death
*protecting your assets from creditors
*establishing control and transfer of ownership of your home health business
At Partners31, our experienced and knowledgeable mergers and acquisitions home care advisors can help guide you through the estate planning and exit planning process. You cannot afford to wait.