Family Business

The Taxpayer Relief Act of 1997 provided for a special estate tax exclusion for qualified family-owned business interests by enacting new Internal Revenue Code Section 2033A. This provision was effective for decedents dying after December 31, 1997. After taking into account the applicable exclusion amount, the maximum exclusion (formerly known as the applicable credit equivalent amount) shielded a maximum of $1.3 million from estate tax.

The IRS Restructuring and Reform Act of 1998 (the "Act") modified these rules. The Act converted the exclusion to a deduction. An executor can elect to take a maximum qualified family-owned business deduction of $675,000. If such an election is made, and the maximum deduction is taken, the applicable exclusion amount (the amount exempted by the applicable credit) is $625,000 regardless of the year of death.

If the qualified family-owned business interest deduction is less than $675,000, the $625,000 applicable exclusion amount is increased by the excess of $675,000 over the amount of the qualified family-owned business deduction allowed. However, the applicable exclusion amount cannot be increased above the amount that would be available if no qualified family-owned business deduction had been taken. IRC Section 2033A is re-designated as IRC Section 2057.

In determining whether your client’s business is eligible for this special treatment consider the following requirements:

The value of the business plus any gifts of interests in the business to qualified heirs must exceed 50% of the client’s adjusted gross estate. The business is considered family-owned if it is owned at least 50% by one family, 70% by two families, or 90% by three families. If it is owned by more than one family, the client’s family must own at least 30% of the business. The business cannot have been publicly traded within three years of the client’s death.
The client or members of the client’s family must have owned and materially participated in the operation of the business for periods totaling five or more years out of the eight-year period preceding the client’s death. The business must pass to a qualified heir.
The client must have been either a citizen or resident of the United States. Qualified heirs include family members and employees who have worked in the business for at least ten years before the client’s death. The principal place of the business must be in the United States.