Overview

Main Menu Name: §2057

Allows an executor to elect a special estate tax treatment for qualified "family owned business interests if the interests comprise more than 50 percent of a decedent's estate and certain other requirements are met.

This deduction was repealed in 2004. The program does not allow you to enter a year past 2003.

In this article:

• Background
• Getting Started
• Entering Data
• Results

Background

An executor can elect a special estate tax deduction for qualified "family-owned business interests" if the interests comprise more than 50 percent of a decedent's estate and certain other requirements are met.

In general, this deduction (when used in combination with the unified credit) exempts from federal estate tax the first $1.3 million of value in qualified family-owned business interests in a decedent's taxable estate. The deduction is limited to $675,000, and the total of the deduction and unified credit applicable exclusion amount (which is $625,000 in 1998) cannot exceed $1.3 million. In other words, estates that claim this special deduction will be limited to a unified credit exclusion amount of $625,000, and will not be able to claim the increases in the unified credit for 1999 through 2003.

A "qualified family owned business interest" is any interest in a trade or business (regardless of the form in which it is held) that also meets the following requirements:

1. It has a principal place of business in the US, and
2. At least 50 percent of the trade or business is held by one family, or at least 70 percent by two families, or 90 percent by three families, as long as the decedent's family owns at least 30 percent of the trade or business.

"Members of an individual's family" are defined as:

1. The individual's spouse
2. The individual's ancestors
3. Lineal descendants of the individual, of the individual's spouse, or of the individual's parents, and
4. The spouses of any such lineal descendants

An interest in a trade or business does not qualify if:

1. The business's (or a related entity's) stock or securities were publicly traded at any time within three years of the decedent's death or,
2. More than 35 percent of the businesses' adjusted ordinary gross income for the year of the decedent's death was personal holding company income.

Reduction in value for excess cash, or marketable securities
The exclusion is reduced to the extent the business holds "excess cash" or marketable securities. Cash or marketable securities in excess of the reasonably expected day-to-day working capital needs reduce the otherwise excludable amount. Cash accumulated for capital acquisitions is not considered "working capital."

Reduction in value for passive assets
The exclusion must also be reduced by the amount of certain "passive assets." Passive assets include any assets that:

1. Produce dividends, interest, rents, royalties, annuities and certain other types of passive in come
2. Are an interest in a trust or partnership;
3. Produce no income
4. Give rise to income from commodities transactions or foreign currency gains
5. Produce income equivalent to interest.

Other requirements
In addition to the other requirements stated above, a decedent's estate qualifies for the family business exclusion only if:

1. Decedent was a U.S. citizen or resident at the time of death, and
2. The aggregate value of the decedent's qualified family- owned business interests that are passed to "qualified heirs" is greater than 50 percent of the decedent's adjusted gross estate (the "50-percent liquidity test"). Qualified heirs include not only actual members of the decedent's family but also any individual who has been actively employed by the trade or business for at least 10 years prior to the date of the decedent's death.
3. If a qualified heir is not a U.S. citizen, any qualified family-owned business interest acquired by that heir must be held in a trust which meets requirements similar to those imposed on QDTs (qualified domestic trusts), or must meet other security criterion.

Participation requirements
To qualify for the beneficial treatment provided, the decedent (or a member of the decedent's family) must have:

1. Owned and materially participated in the trade or business for at least five of the eight years preceding the decedent's date of death,
2. Each qualified heir (or a member of the qualified heir's family) must "materially participate" in the trade or business for at least five years of any eight-year period within 10 years following the decedent's death.

Getting Started

In general, this deduction (when used in combination with the unified credit) exempts from federal estate tax the first $1.3 million of value in qualified family owned business interests in a decedent's taxable estate. The deduction is limited to $675,000, and the total of the deduction and unified credit applicable exclusion amount (which is $625,000 in 1998) cannot exceed $1.3 million. In other words, estates that claim this special deduction will be limited to a unified credit exclusion amount of $625,000 and will not be able to claim the increases in the unified credit for 1999 to 2003.

A "qualified family owned business interest" is any interest in a trade or business (regardless of the form in which it is held) which also meets the following requirements:

• It has a principal place of business in the US, and
• Three families must hold ownership of the trade or business by at least 50 percent by one family, 70 percent by two families, or 90 percent by three families, as long as the decedent's family owns at least 30 percent of the trade or business.

"Members of an individual's family" are defined as:

• The individual's spouse
• The individual's ancestors
• Lineal descendants of the individual, of the individual's spouse, or of the individual's parents, and,
• The spouses of any such lineal descendants

The estate tax calculations take into account the changes in rates and credits under the Economic Growth and Tax Relief Reconciliation Act of 2001.

Entering Data

1. Assumed Year of Death:  Enter the assumed year of the decedent's death.
2. Value of Qualified Family Business Interests in Gross Estate:  Enter the amount of business interests left to "qualified heirs." (Go back to the main screen of the help for this calculation to see the definition of "qualified heir.")
3. Excess Cash and Marketable Securities in Business Value:  Enter the amount of working capital held by the business in excess of the day-to-day working capital needs (determined in a manner similar to Bardahl Manufacturing Corp. v. Commissioner, T.C.Memo. 1965-200).
4. Passive ("Personal Holding Co.") Assets in Business Value:  Enter the total value of any "personal holding company" type assets.
5. Gift Tax Value of Business Interests Held by Family (Not Spouse):  Enter the amount of any taxable gifts of business interests made to family members other than the spouse, regardless of when the gifts were made.
6. Value of Other Assets in Gross Estate:  Enter the total value of all other assets in the gross estate.
7. Gifts to Spouse Within 10 Years (Not Business Interests):  Enter the total value of all gifts made to the spouse (other than interests in the business) within the past 10 years.
8. Other Taxable Gifts Within 3 Years:  Enter the total value of all taxable gifts (other than interests in the business) made within three years of the presumed date of death.
9. All Debts Deductible From Gross Estate:  Enter the total value of all debts that are expected to be deductible from the estate.
10. Qualified Personal Residence Debt:  Enter the amount of qualified mortgage debt included in the total of debts of the estate. (A mortgage debt is "qualified" if the interest is deductible for federal income tax purposes.)
11. Debt Used For Educational and Medical Expenses:  Enter the amount of debt included in the total debt that was incurred by the decedent to pay for educational or medical expenses of the decedent, the decedent's spouse, or the decedent's dependents.
12. Adjusted Taxable Gifts (Business and Non-Business):  Enter the total amount of all taxable gifts (not subject to the annual exclusion or the marital or charitable deductions) made after 1976. This amount should be greater than or equal to the value of "Other taxable gifts within 3 years.
13. Gift Tax Paid on Adjusted Taxable Gifts:  If federal gift tax was paid on any gifts made after 1976 (because the tax on the gifts exceeded the available unified credit), the amount of the tax should be entered here.
14. Estimated Funeral and Administration Expenses:  Enter the estimated amount of all funeral and estate administration expenses.

Results

The program shows the percentage of business owned by a family and whether or not the §2057 deduction may be taken. If the deduction can be taken, the amount of exclusion is calculated along with the federal and state death taxes saved by the deduction.

In order to qualify for the deduction, the adjusted value of the qualified family owned business interests must be more than 50% of the adjusted gross estate. The numerator of the fraction is the value of the decedent's qualified business interests reduced by the value of excess cash and marketable securities held by the business and passive ("personal holding company" assets held by the business and increased by the gift tax value of business interest previously given to other family members (other than the spouse). The value is also reduced by debts of the decedent (other than qualified personal residence debt and debt used for educational or medical expenses) in excess of $10,000.

The denominator of the fraction is the total value of the decedent's gross estate (the value of the business interests not adjusted as described above), less all debts, but increased by the gift tax value of business interests previously given to other family members (other than the spouse), all gifts to the decedent's spouse within the precedent 10 years, and the value of all other taxable gifts (other than business interests) within the previous three years.

The §2057 deduction is limited to $675,000. Also if the estate qualifies for the deduction, the unified credit applicable exclusion amount is $625,000, regardless of the year of death, so that the total of the deduction and the unified credit applicable exclusion amount is not more than $1,300,000. However, if the value of the qualifying business interests is less than $675,000, the unified credit exclusion amount is increased by the difference (but not above the applicable exclusion amount for that year).