Repealing the Estate Tax – This Is an Opportunity to Talk About What Really Matters

America still creates its wealth through small businesses. As the Greatest Generation passes and the Baby Boomers age, we are poised to experience the greatest wealth transfer in the history. The question is, are our heirs positioned to perpetuate this wealth, or will it vanish?  

The old parable of rags to riches to rags in three generations — where an energetic progenitor creates wealth with his or her bare hands, then passes it to the next generation, who fail to regenerate the wealth, and finds it squandered completely by the third generation — remains the common, as opposed to occasional, result. Why do generation after generation create wealth only to see it dissipated? 

When Legacy Counsellors, P.C. was founded in 1994, the federal estate-tax exemption was only $600,000, and the tax rate could exceed 55{06cf2b9696b159f874511d23dbc893eb1ac83014175ed30550cfff22781411e5}. With as much as 50{06cf2b9696b159f874511d23dbc893eb1ac83014175ed30550cfff22781411e5} of an individual’s assets potentially depleted by this tax, many saw the estate tax as the primary culprit preventing particularly business owners from perpetuating the family’s wealth. Avoiding or reducing this tax was an essential first step to passing on wealth to the next generation with any hope of perpetuation. Estate planners deployed a variety of complex tools to avoid or reduce estate taxes, including Credit Shelter Trusts, Q-Tip Trusts, GRITs, GRATs, etc. — all tools used to help families successfully transfer wealth to the next generation without the burden of this confiscatory tax.

Nonetheless, few families managed to perpetuate financial success from one generation to the next. 

For nearly 20 years, the federal estate-tax exemption has been climbing and rates dropping. Today the federal estate tax is a flat 40{06cf2b9696b159f874511d23dbc893eb1ac83014175ed30550cfff22781411e5} and is imposed on estates in excess of $5.6 million. With some planning and proper use of exemptions, a married couple can transfer $11.2 million without federal estate taxes. 

The current administration and Congress have proposed eliminating the federal estate tax altogether, and the Senate would double the current exemptions. Most states have already eliminated their local estate tax. (Massachusetts continues to tax estates in excess of $1 million; however, the rate is only 3.2{06cf2b9696b159f874511d23dbc893eb1ac83014175ed30550cfff22781411e5} to 16{06cf2b9696b159f874511d23dbc893eb1ac83014175ed30550cfff22781411e5}, less than the capital-gains taxes). What is striking is that the reduction in estate tax has not seemed to avoid the inter-generational destruction of wealth, and few families are able to keep a business for more than three generations.

Fear of Failure

In a 2012 study of account holders with investments in excess of $5 million, U.S. Trust asked clients what advice they are not getting from their advisors. By far, the greatest percentage of respondents indicated they were not getting advice on how to prepare children for inheritance, how to prepare the next generation to receive assets, or how to help family members handle wealth. We believe that study, while important, is only symptomatic of a much greater problem.

We Americans do not know how to talk about wealth inter-generationally, and our education system is not designed to teach the practical skills of creating or managing family wealth.

Inter-generational communication of the skills and values that create and preserve wealth is not easy. As with anything, parents need to give their children an opportunity to experiment and fail in order to learn. The business-owner parent who is too protective of his son or daughter or unwilling to give them an opportunity to fail may be denying them an opportunity to learn. This is often perceived as being ‘controlling.’

When we are dealing with the family business, however, many owners may perceive that even small failures are not an option, so important lessons may never be learned. We have found that ‘structure’ and ‘process,’ two fuzzy words that drive many hard-charging entrepreneurs to distraction, can be the key to success in creating the opportunity for the next generation to learn about wealth and business before inheriting outright. 

‘Structure’ involves things like creating carefully controlled vehicles for shared family wealth — vehicles like trusts and family holding companies, which allow partial transfer of assets. This often includes building control systems that simultaneously offer the progenitor sufficient control while creating a means by which the next generation can explore new ideas, redeploy underutilized wealth, and offer the next generation insight and understanding to both current markets and old, reliable values. These structures must simultaneously protect family assets from divorcing spouses, catastrophic creditor suits (car accident, slip and fall, etc.), and even estate taxes.

‘Process’ involves repeatedly seeking opportunity, counting and measuring success and failures, expanding opportunity when success or interest is shown, and reinforcing the structure by continually seeking new opportunities for experimentation and understanding. 

Bottom Line

Too often, the structures families create have been focused exclusively on avoiding the estate tax. By the time we explain and create such structures, the business owner is exhausted and unable to focus on perpetuating the values that have created the family’s wealth.

If the estate-tax exemptions are drastically increased or the federal estate tax is eliminated, we look forward to the opportunity to talk with families about what really matters — structures and processes designed to simultaneously protect family wealth and transfer the knowledge and values required to keep this wealth in the family.