Inheritance planning: a necessary part of estate and gift tax planning.

• Author: Seamon, Dennis

It has been said that more wealth will be passed on to the "baby boom generation" over the next 10 years than has been passed on during any other period in history. Perhaps that explains the increase in "estate planning" and marketing of related services by insurance companies, brokers, lawyers and accountants. Although estate and gift tax planning is definitely a necessity for any wealthy individual, estate and gift tax planners must be careful not to focus only on estate tax savings and ignore inheritance planning" for the beneficiaries.

The following situation is a classic example of what can happen if proper time is not spent with the beneficiaries of gifts and/ or inheritances of closely held corporations or family-owned farms.

Three brothers were given a coal mining company by their mother. The mining company had been established by their father in the 1950s. The company was never a large money maker, so C corporation status was maintained for liability purposes, and all profit was usually paid out as salary. The company acquired some large tracts of land over the years. However, the land was not valued highly because it was purchased as farm land, and it was not cost beneficial to mine all the coal. The father passed away and all assets were left to the mother. The company was somewhat inactive over the last several years, and its only income was a de minimis amount of royalty income received from another coal company doing some mining on its land.

As part of her estate planning, the mother gave the company to her sons while the value was still low, thereby removing the potential for appreciation from her estate. No special use valuation under Sec. 2032A was necessary, due to its low value and the need to reclaim part of the land.

Several years later one of the sons arranged to have an outside company strip mine the remaining coal from the land, and for another company to purchase the land, fill in the stripped area with refuse and reclaim the land. The two deals together will generate between $1 million and $2 million of revenue to the company over the next five years.

The problem is that the company will now be receiving income, the bulk of which will be royalties, thereby making the corporation a personal holding company (PHC). All earnings will be taxed twice, at the corporate level and then again at the shareholder level on the payment of dividends, and maybe even three times (corporate income tax, corporate level tax on...