New IRS Code Excludes Estate Tax on some Family-owned Businesses

Special tax treatment can be elected with respect to a family owned business if the value of the business exceeds 50% of the owner’s total estate (and other conditions are met). If eligible, the estate can exclude the lesser of the value of the family business or the excess of $1.3 Million over the exclusion amount in the year of death.

The new IRS Code is complex and limited, but it will provide a beneficial method of transferring small, family owned businesses in which the business is the primary asset of the owner’s estate.

For instance – in 1998 the individual exclusion amount will be $625,000. If a family business is involved and all other eligibility guidelines are met, the business can be transferred with an exclusion of $675,000 (the difference between the maximum allowable of $1.3 Million and the $625,000 maximum exclusion) of its value.


1. The aggregate value of the business must be more than 50% of the estate value,

2. The business owner must be a U.S. citizen,

3. The executor must elect special tax treatment and file a recapture agreement signed by each person inheriting a portion of the business,

4. The business must be at least 50% owned by one family, 70% owned by two families, or 90% owned by three families (with at least 30% owned by the family of the owner whose interest is being transferred.

Special valuation rules apply that keep a person from “salting” money or passive assets into the business in order to build its value to more than 50% of an estate and a special liquidity test has been created to test the 50% rule.

Finally, a “Recapture Tax” is imposed if during the 10 years following the transfer,

1. the qualified heir ceases to participate in the business,

2. the qualified heir disposes of any portion of his interest except to another family member,

3. the business moves out of the U.S., or

4. the heir no longer is a U.S. citizen.

Within the first six years 100% of the tax is recaptured, 80% in the seventh year, 60% in the eighth year, 40% in the ninth year and 20% in the tenth year.

Obviously, this exclusion was created to permit transition of family owned businesses to other family members who intend to operate the business for many years. Many insurance agencies in the U.S. could qualify for this exclusion but each must be tested individually. If this exclusion can be qualified for a family owned business it may become quite advantageous for an agency owner to maintain ownership of the business’ stock while his/her children operate the agency until his/her death. At that point (if qualified) the business would transition with little or no tax ramification and a stepped-up basis permitting future tax benefit to the new owners, as well.

If you would like Agency Consulting Group, Inc. to conduct a valuation and liquidity and ownership tests to determine if your business would qualify for this exclusion, please call 1-800-779-2430.