Ownership vs. control

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Many small business owners worry about what will happen to their company when they die. Some don’t want to sell their businesses to family members simply because of the potentially large tax liabilities to them and their loved ones.

When a small business owner passes away, the family may be forced to sell the company because of the estate tax. Uncle Sam and the state want their money nine months after the date of death, and the government gets paid before the family.

There are many techniques and planning options available, and the use of charitable vehicles in conjunction with these can yield a powerful result for a family and leave Uncle Sam with next to nothing.

Normally, the ownership and control of assets have been seen as the same thing. But the government doesn’t see it that way. Ownership of assets carries with it maximum taxation.

Control without ownership carries no taxation. If you’re willing to give up ownership while maintaining control, you can have even more wealth to control because a significant portion will not be lost to income, capital gain and estate taxes. If you pay minimal or no taxes, you can have control over much more wealth.

Consider the use of a Charitable Remainder Trust (CRT). Assume a client has $3 million in closely held stock. Selling will incur $600,000 in capital gain taxes, leaving $2.4 million. When the client dies, the government levies the estate tax and the family ends up owning and controlling about $1.2 million, 40 percent of the original amount. However, if the original $3 million worth of stock is transferred to a CRT, the client receives a substantial income tax deduction, and when the trust sells the stock, there are no capital gain taxes because the client no longer “owns” the stock (the trust does, and since it is charitable, there is no capital gain tax) but the client still retains control of the full $3 million. Clients reinvest the money inside the trust (usually in growth and income producing assets), receive an income stream from the trust for the rest of their lives, and at their death, the assets transfer to a charity estate tax free. This money can be left to a family foundation or donor advised fund.

The client has more than $600,000 more in wealth because the client gave up ownership but not control of the asset. Assume the client uses some of the extra income generated by the trust to set up an irrevocable life insurance trust (ILIT) and funds it with a $3 million dollar policy (the original value of the stock). When the client dies, the children retain the full $3 million of wealth the client originally owned, while the money in the CRT passes to the family foundation.

Instead of paying $1.8 million in taxes, the family pays no taxes. The client retains control of the entire $3 million in his lifetime instead of $2.4 million, and receives an income stream for life from the $3 million. The family, instead of ending up with $1.2 million, retained the original $3 million and control of another $3 million in a family foundation, for $6 million in controlled wealth.

This is just one example of a strategy to increase the amount of wealth a client’s family controls. Using traditional estate planning tools such as an ILIT in conjunction with charitable planning techniques can create a powerful one-two punch that benefits the family and charity and leaves Uncle Sam with next to nothing.

Gordon Short, CPA, is an associate with SS&G Financial Services’ Akron office. He can be reached at (330) 668-9696.