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Entrepreneurs are busy people. Often too busy for their own profits, or at least their legacies. You probably pay a lot of attention to your balance sheets and profit and loss statements, but what about estate planning?
Procrastinating on estate planning can be a hidden cost for successful entrepreneurs, but solutions are available, regardless of how young you or your company are currently.
If you’ve ever seen the musical “Rent,” you’re probably humming the catchy “Season of Love” song, a reminder that there are 525,600 minutes in a year. If you run a business that matters, every minute counts. Think of the cost of procrastination as a measure of growing inheritance taxes that become a family obligation and affect your ability to leave a legacy.
For simplicity’s sake, let’s assume your net worth is $50 million and your growth rate is 7.2%. Over 10 years, your additional estate tax is about $20 million. On average, that equates to an increased debt of $166,667 per month. For a net worth of $100 million, that’s $333,334 per month. Tick-tock, tick-tock, tick-tock…
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Inheritance tax: the hidden liability
One particular problem for business owners is that estate taxes can be a “hidden liability” because they are a cash obligation paid directly to the IRS by family members when a business owner passes away. We call this a “hidden liability” because the due date and amount of this liability are unknown.
If you’re the CFO or underwriter on the lender’s side, the debt can be hidden because it’s an estate and family planning issue, not a direct obligation of the company. But if most of your net worth is tied up in businesses or other illiquid assets like real estate, when a multi-million dollar payment comes due, it’s no longer hidden. Hence the tick-tick-tick sound.
For sole proprietors, how this is handled can mean the difference between whether the business and its heirs are able to gain and maintain a competitive advantage, or lose it.
For example, if you are a business owner with a current net worth of $75 million, you need to answer the following question: How can I compete in my industry segment while paying $20 million in taxes in cash to the IRS? No business owner wants to sell their business to pay estate taxes.
Related: 7 Advanced Tax Strategies for the Self-Employed
Responding appropriately to the Zero Inheritance Tax Plan
Conversely, proper planning and positioning can actually provide an opportunity for a long-term competitive advantage. Inheritance tax is the only “voluntary tax” you will be subject to. This may be known as “zero inheritance tax planning,” but it can be the strategy that positions your business for lasting success compared to competitors who don’t have a strong plan.
Incidentally, the cost of “funding” your life insurance issue is not practical once you’re over 55. Premiums become prohibitive with each passing year, and even worse, you may become uninsurable due to health issues that impact your ability to secure adequate coverage.
Know and avoid worst-case scenarios
If you need additional motivation to consider estate tax planning now, consider the impact that an unexpected death could have on your estate, based on timing alone, even if you are not over age 55 and are in good health.
We know that most industries, and the companies that make up an industry, go through major business and economic cycles, usually every 4-6 years. Imagine a scenario where a business owner passes away during the peak of a business cycle, determining the amount owed in estate tax.
Because assets are tied up in illiquid assets (the business), it can take months or years to sell the company in order to pay the estate tax. Unfortunately, if there is an economic downturn shortly after the death, the value of the business will decrease. Essentially, the premature death of the business owner has forced a previously healthy business into a situation where it must be dumped just to pay the estate tax.
Related: 3 Smart Ways Entrepreneurs Can Make Tax-Efficient Investment Decisions
Strategically Plan Your Beneficiaries to Eliminate Inheritance Tax
In my industry, we often hear that there are only three beneficiaries when it comes to estates: the IRS, family, and charity. Potentially, an employee could be a fourth beneficiary, but again, this is unlikely without planning. Therefore, “planning out” the issue is the most effective way to minimize or eliminate the impact of estate taxes.
Assets can be strategically positioned to redirect IRS estate taxes to other beneficiaries. Instead of 60% to family and 40% to the IRS, with proper planning, you can end up with 75% to family and 25% to charity or other beneficiaries.
Related: Real Estate Capital Gains Tax: What You Need to Know
Make a SMART plan to maintain family harmony
Have you ever heard someone complain, “My parents built a great business and my brother destroyed it?” In reality, the brother couldn’t bear to pay the IRS about 50% of the business’ value while fighting to make the business competitive. So it’s not just money that can hurt you with a lack of planning. You can also risk family disputes and litigation. To ensure an efficient and harmonious transition, business succession and estate planning work needs to be done. It’s SMART.vinegarAvenue MaOney aand RPull out T(Extended) Wealth Transfer Planning.
This work also has urgency beyond the unexpected. The looming expiration of current estate tax laws at the end of 2025 will make the burden even heavier. Starting now, you can free up a few hours of your time to turn your growing estate tax burden into a generational asset for your family and community. Start by asking your colleagues and advisors for their input and who you can bring onto your team to create a plan that will set you and your estate up for success.
