Family Businesses Endangered By Estate and Gift Taxes
I came across an interesting article which concludes that federal estate and gift taxes account for the elimination of numerous small businesses, thereby promoting the concentration of wealth in larger firms. I can attest to the accuracy of this conclusion based upon several family businesses that I have worked with over the years.
All businesses have market risks, including competitors and obsolescence of their products. Family businesses have two significant additional risks, succession and estate and gift taxes.
The succession risks are two-fold. First, is there a manager or management team that can continue to operate the business in a profitable manner after current management retires or dies? For example, one of my clients is ready to retire, but has no one in his family or company who would be able to run the business if he retires or dies. He is entertaining offers from larger competitors and venture capital funds.
The second succession issue relates to financial and emotional family issues. Is there a way to treat everyone fairly and keep everyone happy after the patriarch or matriarch dies? As businesses move down generations, family issues often place a heavy burden on the business.
Estate and gift taxes present a major obstacle to successfully passing down the family business. I am currently working with the owners of a third generation family business that has been very successful for approximately 70 years. The management and family succession are aligned in a manner that will allow this business to pass smoothly to the fourth generation. However, finding a way to deal with estate and gift taxes is an enormous problem.
My clients are aggressively attacking the estate and gift tax issue on several fronts. First, they purchased $5 million of life insurance while they were insurable. Second, they have established various trusts to which they have been making gifts over several years. This effort has taken away part of their time that could have been spent in growing the business. More importantly, they have spent significant legal, accounting, appraisal and insurance costs. Despite taking all of these steps, they are still looking at an estate tax bill of $12 million. The estate taxes will drain the house and cash and will force the family to borrow money from the government to pay the remaining estate tax. If the family finances a portion of its estate tax liabilities, profits from the business will be dedicated to paying this liability for several years, leaving the family with insufficient funds to pay for anticipated living expenses. Because of these estate tax issues, the family is evaluating offers from some of its publicly traded competitors.
