Pub. 4 2015-2016 Issue 4

Spring 2016 11 of your assets owned at the time of your death is less than $5,450,000, your estate pays no estate taxes. However, for every dollar over $5,450,000, your estate will pay tax at the rate of 40%. For example, assume that John and Jane both die in 2016 owning the assets listed below.Their estates will pay an estate tax calculated as follows: Dealership - $9,000,000 Residence - $1,500,000 Stock Portfolio - $1,000,000 Other Assets - $2,000,000 Total - $13,500,000 Less Estate Tax Exemption - ($10,900,000) Taxable Estate - $2,600,000 Estate Tax at 40%Tax Rate - $1,040,000 Assume instead that John and Jane live another 15 years and, during that timeframe, John and Jane’s assets grow to double their current value. If the estate tax exemption in the year of John and Jane’s deaths is the same as the current estate tax exemption, John and Jane’s estates will pay an estate tax calculated as follows: Dealership - $18,000,000 Residence - $3,000,000 Stock Portfolio - $2,000,000 Other Assets - $4,000,000 Total - $27,000,000 Less Estate Tax Exemption - ($10,900,000) Taxable Estate - $16,100,000 Estate Tax at 40%Tax Rate - $6,440,000 By transferring interests in the dealership now, all of the future appreciation in John and Jane’s car dealership will belong to their children and would be taxed outside of their estate – resulting in significant estate tax savings. Common Concerns Our clients share with us many concerns regarding the proposed transfer of their dealerships. Here are some common concerns raised by dealers desiring to transfer their dealerships to their children: Q: I want to transfer my business to my children but I want to stay in control. A: Both objectives can be accomplished by transferring non-voting interests in the entity. The best example of this division in control is a limited partnership, which is typically formed to have a single general partner who owns a small percentage interest in the partnership (1%). The general partner operates the business and makes all business decisions. The limited partnership also has one or more limited partners who own the majority of the ownership interests in the partnership (99%) but who have no say in business decisions. By implementing this structure, a dealer could transfer the limited partnership interests to the children – thereby transferring a majority of the equity in the dealership – and still retain control through the general partnership interest. It is possible to use the same division between voting and non-voting interests in a limited liability company, an S corporation and a C corporation. Q: I want to transfer my business to my children but I need the cash flow from the business to maintain my standard of living. A: Once the interests in the dealership are transferred to the children, each child will thereafter receive his or her proportionate share of the cash flow from the dealership. Instead of gifting interests, the dealer could sell interests in the dealership to the children in exchange for promissory notes or in exchange for private annuities, thereby ensuring a steady stream of cash flow from the dealership. While the sale of the interests in the business provides significant estate tax benefits, the sale will also likely have adverse income tax consequences. Therefore, there are other, more advanced, methods of estate planning to consider that may allow sales of interests in the business that do not trigger income taxes. Q: Only one of my children is involved in the dealership. I want tomake sure that she receives my interest in the dealership but I don’t have enough cash to equalize gifts to my other children. A: One possible solution is for you to sell a portion of your interest in the dealership to the child involved in the business in exchange for a promissory note. After your death, your family trust could distribute the remaining interest in the dealership to the child involved in the business and distribute the promissory note in equal shares to the remaining children. This method ensures that the child involved in the business receives the entire dealership while the remaining children receive a valuable, income-producing asset of equal value. Q: I’m not sure whether the manufacturer will allow me to transfer interests in the dealership to my children. A: Each manufacturer has its own criteria for determining whether to allow a dealer to transfer ownership of the dealership. While California law prohibits a manufacturer from denying the widow, widower or heirs designated by a deceased owner the opportunity to participate in the ownership of the dealership for a reasonable time after the death of an owner, working with the manufacturer now to iron out the proposed ownership transfer provides needed certainty. Transferring interests in the entity owning the real property on which the dealership is located is another way to transfer value without running afoul of manufacturer rules. If the same entity owns both the dealership and the real property, depending on the type of entity, it may be possible to separate the dealership and the land into separate entities without causing significant, adverse income tax consequences. While there is no one“correct solution”for all dealership succession plans, starting the process now allows you to choose your successor, provides your successor the time necessary to grow in and develop the business and, ultimately, saves money for your family. Benjamin Franklin stated, “An ounce of prevention is worth a pound of cure.”With forethought, you can ensure that your successors inherit a valuable and growing dealership without the complications associated with leaving your business succession plan undone. Blaine M. Searle, Esq. focuses his practice on business law, tax law and estate planning. He received his J.D. from the University of Oregon, 2003, and his LL.M. in Tax Law from Georgetown University Law Center, 2004. You may contact him for assistance at bsearle@ferruzzo.com , 949.608.6900. Ferruzzo & Ferruzzo, LLP has over thirty-five years of experience advising clients, including numerous car dealers, on multiple areas of law including business transactions, employmentmatters, litigation, real estate transactions, estate planning and tax law. 1 https://www.nada.org/CustomTemplates/DetailPressRelease. aspx?id=21474843413. 2 In either event, the process of transferring the assets to the ultimate recipi- ents, called probate, is long and expensive.