A House subcommittee held a hearing to consider what impact the return of a higher estate tax rate in 2013 would have on small businesses.
Thursday’s hearing of the House Subcommittee on Economic Growth, Tax and Capital Access included testimony from a Phoenix-based CPA who specializes in estate, trust and gift taxes, Thala Taperman Rolnick. She noted that the estate tax has been a moving target for the past 10 years.
“Over the last 10 years, a number of extremely wealthy families have done an excellent job of convincing small business owners into believing that they will lose their businesses to the estate tax,” she said. “In reality, at its current level, it affects very few individuals.”
The amount that could pass estate tax free before 2002 was only $600,000 per person, Rolnick noted in her prepared testimony, and the current amount is $5,120,000. At the end of this year, that amount will drop to $1 million per individual unless Congress acts. The exclusion amount enacted will determine how many small businesses will be affected.
“In 2010, when the exclusion amount was $3.5 million, the Centers for Disease Control and Preventions determined that 2,437,163 people died,” Rolnick pointed out. “According to IRS statistics, only 15,191 of these individuals were required to file an estate return. Of those, only 6,711 paid any estate tax. Of those paying the estate tax, only 4,425 returns included general partnerships, sole proprietorships, closely held C-corporation stock, farms and S-corporation stock. The total tax collected from all returns was $69,151,158,000.”
She recommended that there should be greater permanence in the estate tax code, including the enactment of a permanent estate tax exclusion set at a rate between $3.5 million and $5 million per person. Rolnick said it should be matched for the Generation Skipping Tax and adjusted for inflation. She also suggested permanently rejoining the gift and estate tax with the same exclusion amount.
In addition, she recommended making portability permanent with a few modifications, and preserving reasonable valuation discounts for operating businesses where the death of an owner truly reduces the value of the business. In addition, she urged Congress to pass a simpler provision to replace Section 2057 of the Tax Code with a “Family Farm and Business Preservation Exemption” that would provide an additional exemption, up to a specific dollar amount, such as $1.5 million, for an interest in an operating family business with a total value under perhaps $10 million. To pay for these provisions, she suggested readjusting the estate tax rate brackets to restore progressivity above the exemption level to provide better fairness for smaller estates, and to reform the Grantor Retained Annuity Trust provisions and pass limitations on excessive discounts where they hold primarily liquid securities.
Neil Katz, the managing partner in Katz, Bernstein & Katz, a law firm in Syosset, N.Y., which specializes in tax matters including estate planning for closely held and family businesses, also testified before the subcommittee.
“The issues faced by business owners and their families start long before death,” he said. “With the threat of an estate tax looming, the family will often require sophisticated planning to attempt to reduce the exposure that the heirs will face. This planning does not come without a price. To design and implement an estate tax plan can cost an individual anywhere from $5,000 to $50,000 (or more). The end result of such planning is often the creation of trusts to hold business interests which makes the running of the business more complicated. To most, however, the cost of the planning is only a minor issue. A more significant problem may be created if part of the planning recommendation includes transferring interests in the business to future generations. Often, this decision is one that the owner may not be prepared, emotionally or economically, to make at the time.”
Katz noted that in his practice, he and his colleagues often deal with clients who are dealing with emotional issues when trying to decide on how to transfer business interests to their children or to trusts for their children’s benefit.
“Small businesses are struggling in today’s economy to meet their obligations and provide for the business owners and their families,” he said. “Adding the burden of an estate tax to be due, or one currently due as a result of the death of the former business owner, can make the operation of a small business a nearly impossible task. While the estate tax can cause an incredible burden on the small business owner, the constant changes in the estate tax law over the last 12 years, coupled with the uncertainty of the future rules, have made it even more difficult. This point cannot be overemphasized. If Congress could establish rules that business owners could be assured would survive for a period of 10 to 15 years, then they would at least have a chance (albeit a difficult battle) to plan for the tax burden. The world of the unknown that Congress has created since the enactment of EGTRRA, in 2001, has created an unworkable scenario for business owners.”
Karen Madonia, CFO of Illco, a Chicago-area distributor of heating, ventilation, air-conditioning and refrigeration equipment, parts and supplies, testified on behalf of the Heating, Air-Conditioning and Refrigeration Distributors International trade association. She described the uncertainties faced by her father in the family-owned business he has been operating since 1973.
“Over the last few years, my dad has spent countless hours and entirely too much money trying to navigate the estate planning waters. Instead of focusing on growing his business so he can open more branches and employ more people, he has had to strategize about how to pass his company on to his kids without having to dismantle it,” she said. “And if that isn’t enough of a challenge, he has had to do it with an ever-changing tax landscape. Since he started this process in 2008, there have been several changes in estate tax law. We’ve gone from an exemption of $2,000,000 and a tax rate of 45 percent in 2008, to an exemption of $3,500,000 and tax rate of 45 percent in 2009, to a full estate tax repeal in 2010, to an exemption of $5,000,000 and a tax rate of 35 percent in 2011 and 2012. In 2013, the exemption is scheduled to fall back to $1,000,000 with a tax rate of 55 percent. How can a business owner actually formulate an estate plan if the rules change every year?”
Michael Flesher, president of the American Rental Association, also runs a family-owned business, Taylor Rental Center in Vestal and Ithaca, N.Y. He noted that his trade association supports a permanent extension of current law, which allows a $5,000,000 per person exemption indexed for inflation and a 35 percent rate on the remaining assets in the estate. Current law also provides for a stepped-up basis on all assets in the estate. “We believe it is critical to pass this permanent extension so that small businesses like mine have the certainty we need to plan for the future,” he said.
Subcommittee chairman Joe Walsh, R-Ill., pointed to Benjamin Franklin’s oft-quoted maxim about the certainty of death and taxes. “For many years, death and taxes have gone together in the United States, but the structure of those taxes and the rates have varied greatly,” he said. “For family-owned small businesses and farms, estate taxes are a significant concern. Isn’t it enough for them to worry about new and higher taxes, compliance with the health care law, additional regulations, accessing capital, and simply staying afloat while they are alive? But these small business owners must also try to blunt the impact of estate taxes following their demise. If Congress fails to act by the end of this year, the current federal estate tax law will revert to significantly higher pre-2001 levels. And that’s not including any estate taxes imposed by states.”
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