April 2010 / Volume 8, No. 1


While the day-to-day operation of any business is a considerable challenge, planning for a family business or other closely-held business interest presents a number of other challenging issues for the business owners and their advisors.  This article will highlight some of the primary planning issues for the closely-held business.

Shareholder, Operating or Partnership Agreement.  The primary device for the governance of the closely-held business is the shareholder agreement for a corporation (along with the corporate by-laws and sometimes a voting trust agreement), the operating agreement for a limited liability company, or the partnership agreement for a partnership (collectively referred to as a “Management Agreement”).  The Management Agreement is used to cover many facets of a business operation, including who will be elected as the directors, officers, managers, or general partners, whether a majority vote or larger percentage of the equity interests will be required to approve certain decisions, and to impose restrictions on transfers of equity interests, which usually involve a right of first refusal in the event an equity interest holder wants to sell or transfer the interest to another party.

Buy-Sell Provision.  Another significant aspect of any Management Agreement is a “buy-sell” provision that provides for the purchase of the equity interest upon the death of an equity owner and a formula or method for establishing a purchase price.  This is often the most difficult aspect of any Management Agreement, requiring the selection of one of various valuation techniques, such as an appraisal, the use of book value or adjusted book value, a formula, or sometimes a fixed price that is subject to adjustment from year to year.  The selection of the valuation method has to meet various criteria, including a fair price for the equity interest, a value that will pass Internal Revenue Service scrutiny, and a price that the company or surviving equity owners can afford to pay without jeopardizing the ongoing successful operation of the business.

Buy-Sell Funding Techniques and Estate Taxes.  Providing funds for the buy-sell agreement and/or for the payment of estate taxes upon the death of an equity owner is an essential issue for most closely-held businesses.  Life insurance is often used to provide liquidity, and its use requires a determination of whether the entity will own the insurance, or the equity owners, or an irrevocable life insurance trust.  In addition to life insurance, installment payments are sometimes used to allow funds to be paid over a period time and avoid draining the company of funds needed for operating expenses and to avoid having the company use its bank line of credit to finance an equity purchase. 

For federal estate tax purposes, Code Section 6166 allows the installment payment of estate taxes attributable to the closely-held business if the value of the equity interest represents at least 20% of the voting interests in the company and the equity interest is at least 35% of the value of the adjusted gross estate of the deceased equity owner.  The installments can be spread over a period of up to 15 years, with interest only for the first 5 years.  A special 2% interest rate applies to the first $1.3 million of taxable value (For 2010, there is no estate tax). 

Succession Planning.  Another essential element of planning for the closely-held business is succession planning, which often involves various gifting techniques to transfer equity interests to the family of the equity owner while retaining voting control in the senior family member.  Gifting of minority interests is often used, allowing gifts that are discounted based on the transfer of minority non-controlling interests and using recognized valuation concepts that allow a marketability discount for the equity interests in a non-publicly traded company.  Non-voting equity interests are sometimes used to transfer equity in the company while retaining voting control in the senior family member.  Other more sophisticated transfer techniques include a gift to a grantor retained annuity trust or an installment sale of an equity interest to an irrevocable grantor trust, either of which can be used to transfer larger equity interests without incurring a gift tax if a transfer exceeds $1 million in value.  

ConclusionPlanning for the closely-held business requires attention to matters which are not necessarily part of the day-to-day operation of the business but which will become critically important at some point in every business.  There is an interplay of management issues, restrictions on the transfer of equity interests, succession planning, and buy-sell arrangements that require the use of legal, tax, financial and insurance advisors who are familiar with the legal and tax issues applicable to such arrangements and with the particular needs of the closely-held business, as each business has a unique set of circumstances.

By Ronald G. Silbert


With the failure of the U.S. Congress to enact estate tax legislation that was proposed to have the estate tax continued after 2009 with an exemption of $3.5 million, there is now a very uncertain estate planning environment - there is no estate tax at present, for 2010, but effective January 1, 2011, the estate tax is scheduled to return with an exemption of only $1 million.  As a result, during this transitory period individuals will have to determine if their estate plan documents provide for the intended allocation of assets.  This article summarizes the estate, gift and generation-skipping transfer tax laws as currently in effect, but this could change at any time if Congress proceeds with new tax legislation.


Estate Tax and Generation-Skipping Tax:  None

Step-up in Basis Replaced With Adjusted Cost Basis. For 2010, the tax bases of a decedent’s assets are not adjusted (generally increased) to equal the fair market value of the assets as of the decedent’s date of death.  Instead, the bases in the decedent’s assets will generally be equal to the lesser of: (1) the decedent’s cost basis in the assets; or (2) the fair market value of such assets as of the decedent’s date of death.  The assets of the estate will then receive up to a $1.3 million increase in basis, and assets received by a surviving spouse will receive up to an additional $3 million increase in basis.  This makes it even more important to maintain records as to the cost of an individual’s investments.    

Gift Tax.  The gift tax remains.  Each individual can make present interest gifts of up to $13,000 per donee, annually ($26,000 if split with one’s spouse).  The $1 million gift tax exemption amount will still apply to taxable gifts, but the maximum gift tax rate is reduced from 45% to 35%, which means that 2010 might be a good year to make larger taxable gifts. 

Repeal of Illinois Estate Tax.  For 2010, the Illinois estate tax is eliminated.

January 1, 2011:

Estate and Gift Tax.  The lifetime gift and estate tax exemption is scheduled to be unified again at $1 million per taxpayer.  Once a taxpayer’s taxable gifts or taxable estate exceeds the $1 million exemption, transfers in excess of the exemption are subject to gift or estate tax. The gift and estate tax rates reach 55% on transfers in excess of $3 million.

Generation-Skipping Transfer Tax. The generation-skipping transfer tax exemption is scheduled to be $1,060,000, plus an adjustment for inflation since 2002. The generation-skipping transfer tax rate will be a flat 55%.

State Death Tax Credit.  In 2011 the state death tax credit against the federal estate tax will be reinstated.  This will cause the Illinois estate tax to be reinstated (as well as the estate tax in other states, such as Florida).

EFFECT ON ESTATE PLANNING:  Under a typical estate plan, upon the death of the first spouse, a decedent’s trust commonly allocates trust assets to a “credit shelter trust” equal to the deceased spouse’s unused gift and estate tax exemption.  The repeal of the estate tax for the year 2010 may cause all of the trust assets to be allocated to the credit shelter trust since no assets have to be transferred to the surviving spouse to reduce the estate tax to zero.  This may not be the result the individual intended if the beneficiary of the credit shelter trust is not the surviving spouse.

CONCLUSIONThe current uncertainty as to what will happen with the estate and gift tax laws makes it very difficult to do any long-term planning or updating of an individual’s estate plan documents, but, as always, a periodic estate plan review is essential, and the current estate tax situation makes such a review even more important.

By Eileen B. Cozzi

Schoenberg Finkel Newman & Rosenberg, LLC (312) 648-2300

This newsletter is not intended to be legal or tax advice and is not a substitute for obtaining legal or tax advice. This Newsletter is deemed to be advertising material by the Illinois Supreme Court.