Providing financial security for one’s family is the main reason many contractors start a construction company. But efforts to support the family estate will be in vain unless business owners can manage one obstacle: estate taxes.
It’s challenging to create financial strategies that depend on tax laws that are always changing. In 2009, an estate could have passed up to $3.5 million to its heirs before incurring federal estate taxes at a maximum rate of 45 percent. In 2010, the estate tax was repealed, but in 2011, it is scheduled to return with a maximum exemption of $1 million and a top rate of 55 percent.
However, this too may change, as Congress is considering several estate tax proposals. With all the back-and-forth on Capitol Hill, it appears likely no decision will be made before the end of the year.
Contractors that don’t consider themselves wealthy enough to incur these taxes must remember that virtually every asset—home, car, life insurance policy, IRA and 401(k)—may be included in a taxable estate. These assets could push an estate over the exemption amount, costing heirs a substantial amount in estate taxes.
Estate Considerations
One strategy to consider is the irrevocable life insurance trust (ILIT), which keeps life insurance out of one’s taxable estate. For example, if a contractor owned a $1 million life insurance policy, and it was subject to an estate tax rate of 45 percent, its beneficiaries would receive a death benefit of just $550,000. But if the contractor established an ILIT with a new insurance policy, the trust would own the policy and distribute the proceeds to the chosen beneficiaries.
Another estate planning option is a charitable remainder trust, which could be useful if a contractor has a sizable amount of assets, such as stocks, that have appreciated significantly since being purchased. If these assets were kept in the estate, the heirs would inherit them on a “stepped-up” basis, which, in plain language, means the value of the stocks would be the same as their fair market value on the date of the contractor’s death.
However, in 2010 only, the step-up basis is limited to $1.3 million for children or other heirs, and $3 million for a surviving spouse. Beyond those figures, heirs would assume, or carry over, the basis amount the contractor paid for the assets. In 2011, full step-up is scheduled to return.
Removing the stocks from the taxable estate by placing them in a charitable remainder trust could provide an income stream for life once the trust sells the stocks. This income could be used to make gifts to loved ones, further reducing the size of the taxable estate.
An individual may give up to $13,000 per year (and up to $1 million during a lifetime) to as many individuals as he chooses without incurring gift taxes.
Putting estate plans in order early could help loved ones benefit far into the future. Before making any decisions, consult with an estate planning professional and a tax advisor, as well as an estate planning attorney familiar with the construction industry.
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Wednesday, February 8, 2012