Gifts of closely held business stock may sacrifice future savings.

• Author: Liguori, Albert W.

Successful estate tax planning involves many alternatives. Adoption of an overall estate tax plan takes many of these alternatives into account. The use of one or more planning techniques depends on a taxpayer's personal, philosophical and financial goals.

When an owner of a closely held business dies, Sec. 6166 allows the estate to defer payment of the portion of the estate tax attributable to the business interest over 15 years. Interest will accrue on the unpaid portion of the tax, but under Sec. 6601 (j), the rate is only 4% on the first $1 million in value of the closely held business interest included in the gross estate.

Additional relief proposed: President Clinton's recent budget (proposed to Congress on Feb. 6, 1997) includes a provision that would increase the value of business interests eligible for the reduced rate of interest to $2.5 million. It would also reduce the interest rate to 2%, although the interest payments would no longer be deductible by the estate.

Caution: To qualify under current law (and under the President's proposal), the business interest must exceed 35% of the decedent's adjusted gross estate (net of funeral and administration expenses, claims and outstanding debts). If, as a result of lifetime gifts, the value of the closely held business does not meet this threshold, the executor cannot take advantage of this provision.

Example: B has assets valued at $7,000,000, which include his 25% interest in B Inc. (worth $2,500,000). If B died without making any gifts, B's estate would be entitled to make the Sec. 6166 election (see below). If, on the other hand, B gives $300,000 of B Inc. stock to his children before his death, the retained value of B Inc. in his estate would no longer exceed 35% of his total estate.

No gift After $300.000 gift Value of business $2,500,000 35.7% $2,500,000 37.3% Other assets 4,500,000 64.3% 4,200,000 62.7% Total estate value $7,000,000 100.0% $6,700,000 100.0% Result: By making gifts of the closely held stock, B has forfeited the opportunity for his estate to make the Sec. 6166 election.

Even if the value of B Inc. exceeded the 35% threshold after these gifts, the portion of B's estate entitled to the preferential interest rate on the deferred tax will be reduced below the upper limit of $2.5 million under the President's proposal.

Suggestion: To take full advantage of the proposal, B should not have diminished his business holdings below 35% and not below $2.5 million. Instead...