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Spreading The Wealth

Transferring part of your business to your children now could lower their taxes later.

You've worked hard building your business, but like many busy entrepreneurs, you probably haven't spent much time planning for what will happen to the company when you're no longer around. Enter the family limited partnership, a popular estate-planning device that may be just what you need to keep your company in the family and avoid painful tax consequences.

Planning for a business transfer is never a cake walk, but to ease the burden on your family, it's necessary--and the sooner you do it, the better. This is especially important if you operate a family business and want the company to stay in the family when you decide to step down or if some unexpected event transpires. Estate taxes can hit family businesses hard because the full value of a parent's business can be included in the parent's estate when he or she dies.

Estate tax is one of the highest taxes levied on individuals. The first $600,000 of a person's estate is exempt from federal estate tax, but amounts above the exempt portion are subject to a graduated tax ranging from 37 percent to a whopping 55 percent. One thing to keep in mind is that you can give up to $10,000 per year during your lifetime ($20,000 if your spouse joins in) to as many individuals as you wish without incurring gift taxes. Tax experts recommend you make use of this benefit to transfer wealth and, ultimately, tax liability.

A similar strategy is employed when you use a family limited partnership to transfer a business. With a family limited partnership, the business owner remains in control of the business while giving away portions of the company to family members, resulting in significant tax savings, says Mark Stutman, a partner in the Philadelphia office of accounting firm Grant Thornton LLP.

For example, if you started your business with a $10,000 investment many years ago and it's now worth $1 million, you'll pay a hefty capital gains tax if you try to sell it. And if you pass away with no succession plan in place, your heirs will be hit with sizable estate taxes. But with a family limited partnership, the same $1 million business, with a discount of 40 percent (the average allowable amount, which will vary depending on industry, percentage of ownership and what kind of secondary market exists for the type of business), would have a net value of $600,000. If you transfer half the business during your lifetime, you would have transferred $300,000 worth of value, which would have been $500,000 without the discount, explains Stutman.

To set up a family limited partnership, the owner transfers the assets of the company to the partnership, says Howard R. Gladston, an estate-planning attorney with New York City law firm Ballon Stoll Bader & Nadler. The owner, as general partner, maintains control over the limited partnership as well as the overall business, and immediately gives partial ownership of the partnership to his or her children.

Once the partnership is in place, the operation of the company doesn't have to change. "As a general partner of the family limited partnership," says Gladston, "the [business owner] still receives a salary and can make all the management decisions in the business."

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This article was originally published in the July 1997 print edition of Entrepreneur with the headline: Spreading The Wealth.

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