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Why Now is the Right Time to Execute Succession Plans

With the highest estate tax exemption and the lowest intra-family interest rates in history, this may be the most opportune moment in recent memory to transfer interests in your enterprises.

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Despite the uncertainty surrounding COVID-19 and the upcoming election, for business owners considering succession plans, this may be the most opportune moment in recent memory to transfer interests in their enterprises. Currently, we have the highest estate tax exemption and the lowest intra-family interest rates in history. That combination alone is significant, but when mixed with the potential for lower estate and gift tax exemptions and depressed business valuations, you have a potent catalyst for transitioning ownership. Anyone with a taxable estate considering a shift of assets to the next generation, and particularly those with operating businesses, should analyze the efficacy of making gifts in 2020.

Changing Landscape

As many are aware, the federal exemption from transfer taxes is at all-time highs. Under current law, each individual may transfer up to $11.58 million (indexed for inflation) of assets ($23.16 million for a married couple) during his or her lifetime without incurring federal gift, estate or generation-skipping transfer (GST) tax. The current maximum federal gift and estate tax rate and the current maximum federal GST tax rate is 40 percent. While the exemption level is not scheduled to be reduced until the end of 2025, it is anyone’s guess whether it will remain intact through that date. Depending on the impending presidential election results, it is even possible that the exemption is significantly decreased as early as 2021. If the exemption level is reduced, taxpayers who did not take action under current law may miss out on the opportunity to utilize the historically high exemption. Taxpayers who do make transfers this year can do so with confidence since the IRS confirmed that it will not attempt a “clawback” of tax if the exemption amount decreases.

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Business Valuations

The economic environment may create additional incentives to consider transferring your business. The global pandemic has affected various industries, and while valuations in some parts of the domestic public markets remain high, many private companies have been negatively impacted. It may seem counterintuitive, but lower appraised values can be beneficial in a business’s succession planning. Often, with successful private enterprise, the estate tax looms in the background as an unaddressed liability. But if a business owner is willing to transfer all or a portion of the private company to successive generations now, lower appraised values mean more wealth can be shifted and have the possibility to grow free of gift, estate or GST tax in the future.

Interest Rates

Many of the techniques used to transfer assets intergenerationally are based on interest rates which are near the lowest they have been in history. Each month, the IRS releases the updated Section 7520 and Applicable Federal Rates (AFR). These rates are used for transfer techniques like GRATs and intra-family loans. In October, the 7520 rate is 40 bps, and the Mid-Term Annual AFR (used for loans with terms of 3 to 9 years) is 38 bps. Low interest rates offer low hurdles over which growth on private company assets can be transferred to heirs.

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Year-End Rush

The combination of potentially vanishing exemptions, low business valuations, and low interest rates is likely to cause a late-year rush of business owners looking to implement succession plans, particularly if Joe Biden wins the election. Many transfer techniques take time to set up; trusts need to be drafted and funded, EINs may need to be assigned and closely held businesses will need formal appraisals to transfer an interest in the company. It is advisable to begin this process early. If you have not begun already, your financial advisor, CPA and attorney are a good place to start. Putting them on notice before the calls start pouring in is a great way to avoid the crunch in December.

Joseph Roberts is a senior wealth strategist at Rockefeller Capital Management.

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