Special Exemption for Family-Owned
If qualified family-owned business interests (QFOBIs) make up more than 50
percent of your taxable estate, you may benefit from a special provision that
can increase your total effective exemption from estate
tax to $1.3 million.
If an estate is eligible and elects to take the qualified family-owned
business (QFOB) deduction, up to $675,000 of the adjusted value of QFOBIs may be
deducted from the value of the estate. From the $675,000 maximum, you must
subtract some of the amount that is effectively exempt from estate tax under the
general provisions of the law. More specifically, you must subtract the portion
of the general exemption amount that exceeds $625,000.
The general exemption amount is scheduled to rise to $1 million in 2002 and
2003. So, the "extra" exemption benefit for small business will shrink
from $625,000 in 2000-2001, to $300,000 in 2002-2003.
The QFOB deduction has been criticized as being overly complicated and not
very helpful to the estates of small family business owners. Starting in 2004,
this controversial deduction is scheduled to be eliminated. The elimination of
this deduction, however, is more than made up by the increased estate tax
exclusion amounts which rise to $1.5 million in 2004-2005, $2 million in
2006-2008, and $3.5 million in 2009.
To qualify for the family business exemption, your business and your heirs
must meet certain criteria.
- The business interest must comprise more than 50 percent of your estate,
which may mean that you need to give away some non-business assets before
- The principal place of business must be in the United States.
- The business must be owned at least 50 percent by one family, 70 percent
by two families, or 90 percent by three families. Members of "one
family" include your spouse; your ancestors; descendants of yourself,
spouse, or ancestors; and the spouses of such descendants.
- The business's stock or securities must not have been publicly traded at
any time within three years of your death.
- There are restrictions on the amount of passive assets, excess cash,
marketable securities, or holding company income the business may have.
- The value of the business that passes to qualified heirs must exceed 50%
of the estate's value. "Qualified heirs" include people who have
been employed by the business for at least 10 years, and members of your
family. Certain lifetime gifts to qualified heirs are also counted in this
- You must have owned and materially participated in the business for at
least five of the eight years preceding your death.
- Each qualified heir, or a member of the heir's family, must materially
participate in the trade or business for five out of any eight years in the
10 year period following your death. Exactly what "material
participation" means can vary depending on the industry, but physical
work and participation in management decisions are the main factors to be
- If any qualified heir disposes of his business interest within 10 years of
your death, other than by a disposition to a member of his family or a
conservation contribution, a portion of the estate tax reduction may be
"recaptured;" that is, it may have to be repaid to the IRS.
You leave your business to your two children. Your daughter
materially participates in the business, but your son does not.
Both heirs meet the material participation rule, since your
daughter is a member of the son's family.
However, if the daughter stopped participating in the
business within 10 years of your death, neither heir would meet
These are the major requirements you need to meet, but the law has a number
of complicated twists and turns, and if you want to take full advantage of it,
you'll definitely need to consult an estate planning professional.