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Entrepreneurs are busy. Often too busy for their own good or at least the good of their legacy. You’re likely very dialed into your balance sheet and P&L, but what about estate planning?
Procrastinating on estate planning can become a hidden cost for successful entrepreneurs, and the solution is available to you regardless of how young you or your company are today.
If you have seen the musical “Rent,” you likely hum along to the very memorable “Season of Love” song that reminds us that there are 525,600 minutes in a year. Each minute matters when you have a valuable business. Think of the cost of procrastination as a measure of the growing estate tax liability that can become an obligation that your family bears and one that impacts your ability to leave a legacy.
To put it into perspective, assume a $50 million net worth that grows at 7.2%. The additional estate tax over ten years is approximately $20 million. This translates into an increased liability averaging $166,667 per month. A net worth of $100 million becomes $333,334 per month. Tick, tick, tick…
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The hidden liability that is estate tax
The problem for business owners, in particular, is that estate tax can be a “hidden liability,” as it is an obligation the family pays directly in cash to the IRS when you are gone. We call it hidden because this liability has an unknown due date and amount.
If you are your lender’s CFO or an underwriter, the liability can be hidden because it is an estate and family planning issue versus a direct company obligation. But if most of your net worth is tied up in the business or other illiquid assets like real estate, it is no longer hidden when millions of dollars come due. Thus, the tick, tick, tick becomes “BOOM!”
For a private business owner, how this is handled can mean the difference between gaining and sustaining a competitive advantage for your business and heirs and losing it.
For example, for a business owner with a $75 million net worth today, you will need to answer: How do you pay $20 million in taxes in cash to the IRS and still compete in your industry segment? No business owner wants to sell their business to pay the estate tax liability.
Related: 7 Advanced Tax Strategies for the Self-Employed
Properly position for a zero estate tax plan
Conversely, proper planning and positioning can actually provide an opportunity to enhance your long-term competitive position. The estate tax is the only “voluntary tax” you get. You may know it as a “zero estate tax plan,” – and relative to your competitors who may not have a strong plan, it can be a strategy to position your business for enduring success.
By the way, if you are over 55, the cost of “funding away” the problem with life insurance is not feasible. The cost of insurance becomes prohibitively expensive with each passing year, or worse, it could become unavailable to you due to health issues that may impact your ability to secure adequate coverage.
Know and avoid this worst-case scenario
If you need an additional incentive to consider your estate tax plan now, even if you’re not over age 55 and are in excellent health, consider the impact your unexpected demise could have on your estate based on timing alone.
We know that most industries – and the companies that make up an industry – go through significant business and economic cycles, typically every 4-6 years. Imagine a scenario where the business owner dies at the business cycle’s peak, which establishes the amount due as an estate tax.
Because the wealth is tied up in an illiquid asset (the business), it takes several months up to a few years to sell the company to pay the estate taxes. Unfortunately, a down business cycle soon after the death pulls the value of the business south. Essentially, the untimely death of the business owner positioned the otherwise healthy business for a fire sale simply to pay the estate taxes.
Related: 3 Smart Ways Entrepreneurs Can Make Tax-Efficient Investment Decisions
Strategically plan your beneficiaries to eliminate estate tax
In my business, we like to say that there are only three beneficiaries when it comes to your estate: the IRS, family, and charity. Potentially, your employees can become a fourth beneficiary, but again, without a plan, that’s an unlikely outcome. Thus, “planning away” the problem becomes the most effective way to minimize or eliminate estate tax consequences.
It is possible to strategically position your estate and redirect the IRS estate tax to the other beneficiaries. Rather than 60% family and 40% IRS, a good plan can make it closer to 75% family and 25% to charities or other beneficiaries.
Related: Capital Gains Tax on Real Estate: Here’s What You Need To Know
Create a SMART plan to preserve family harmony
Have you ever heard someone complain, “My parents built a great business, but my brother ran it into the ground.” The reality likely was that the brother couldn’t overcome paying the IRS roughly 50% of the value of the business to the IRS while fighting to keep the business competitive. So, it’s not just the money that stings due to poor planning; the fighting and litigation risk among family members can ensue. The business succession and estate planning work must be done to create an efficient and harmonious transition. It is a SMART (Save Money And Reduce Tensions) wealth transition plan.
There’s some urgency attached to this task beyond untimely events. The impending expiration of current estate tax laws at the end of 2025 will worsen the burden. You have a good time horizon to work with if you start now and give a few hours to converting a growing estate tax liability into a multi-generational asset for the family and your community. Start by asking your peers or advisors for their perspectives and who you might invite onto your team to help you create a plan that sets you and your legacy up for success.