Business Transition Planning Terms
Estate Tax Planning Concepts
Estate: Everything of value (all property, assets and liabilities) that a person owns while living or at the time of death. There are different ways to measure the value of an estate: the taxable estate (property subject to estate taxation), the probate estate (property that must go through probate), and the net estate (the net value of the property: gross estate minus debt).
Estate Planning: Process designed to conserve estate assets before and after death, distribute property according to the estate owner's wishes, minimize federal estate and state inheritance taxes, provide estate liquidity to meet costs of estate settlement, and provide for the family's financial needs.
Estate Taxes: Taxes imposed on the "privilege" of transferring property by reason of death. Estate tax is most commonly used in reference to the tax imposed by the Federal Government rather than the state government. Estate tax premise — raise revenue for federal government and break up a family's wealth, so that the nation's wealth doesn't concentrate in the hands of a few families.
A-B Trust Estate Plan: A type of plan utilized by married couples; two trusts (Trust A and Trust B) are created at death of first spouse. By dividing the decedent's estate into two trusts at first death, each spouse can pass the maximum amount of property allowed to avoid federal estate taxes (currently $2 million in tax year 2008). Trust A refers to the Marital Trust and Trust B refers to the Bypass Trust. If structured correctly, both spouses together can transfer up to $4 million to family without estate tax.
Unlimited Marital Deduction: The tax law that allows a person to give an unlimited value of property as a gift, or leave an estate of unlimited value to his or her spouse without a gift or estate tax being assessed. The value of the property passing to the surviving spouse under the marital deduction is "deducted" from the deceased spouse's estate before federal estate taxes are calculated on the estate. Proper planning and use of the deduction allows more property to pass estate tax-free to the family. The marital deduction property can be distributed outright to spouse or via a trust.
Marital Deduction "A" Trust: The trust which "receives" the property passed under the marital deduction laws, from the deceased spouse's estate to the surviving spouse. Property in the marital deduction trust will be included as part of the surviving spouse's estate (for estate tax purposes) when he or she dies.
Bypass "B" Trust: An estate planning device (also called a "Family Trust" or "Credit Shelter Trust" or the "B Trust" in an "A-B Trust" estate plan where the A Trust funds the marital deduction) used to minimize the combined estate taxes payable by spouses. At death of first spouse, the estate is divided into two parts; a part equal to estate tax exclusion is placed in B Trust to benefit the surviving spouse without being taxed at his / her death; the other part passes outright to surviving spouse or is placed in the A Trust.
Probate Concepts
Probate: A court procedure for settling the affairs of a decedent by formally proving the validity of a will and establishing the legal transfer of property to beneficiaries. The court establishes the authenticity of the will (if any), appoints the executor, identifies heirs and creditors, directs payment of debts and taxes, and oversees distributions, including the legal transfer of property to beneficiaries according to the will or state law in the absence of a will.
Probate Court: The part of the judicial system dedicated to handling probate matters which includes settlement of testate and intestate estates, adoptions, appointment of guardians, name changes, and other matters.
Testate: A person who dies with having made a valid will.
Will: A legal document stating the intentions and desires of a deceased person concerning the distribution of his or her property, and management of his or her affairs following his or her death. State law dictates the legality of a will. It may also designate guardians for your children.
Beneficiary: A person who receives benefits under a will.
Executor: A person nominated in a will and appointed by a court to handle the administration and settle the estate of a deceased.
Letters Testamentary: A formal court order issued by a probate judge, giving the executor authority to administer the estate under the provisions of the decedent's will to conduct business, contract, sell estate property, pay bills, distribute estate property, and otherwise act on behalf of the estate.
Guardian: A person designated by court appointment and given the responsibility of managing the personal affairs of a minor child. You have the right to name a guardian for your minor children in your will.
Intestate: A person who dies without having made a valid will.
Intestate Succession: The distribution of property to heirs according to the statutes of the state of residency upon the death of a person who owned the property but did not leave a valid will.
Heir: A person entitled by law to inherit part or all of the estate of an ancestor who died without leaving a valid will.
Probate Estate: A deceased person's property which is subject to the probate process. Property held in a revocable living trust, and property such as life insurance, annuity, and qualified plans such as IRAs or 401ks is usually not considered part of the probate estate.
Gross Estate: The total value of all property in which a deceased had an interest. The total value must be included in his or her estate for federal tax purposes.
Ancillary Probate: A probate proceeding conducted in a state other than the state where the decedent lived and the primary probate occurs.
Uniform Transfer To Minors Act (UTMA): A method to hold property for the benefit of a minor, which is similar to a trust but the rules are governed by state law. Makes it simple and convenient to establish accounts on behalf of minors (formerly known as UGMA – Uniform Gift to Minor Act).
Fiduciary Concepts
Fiduciary: A person with the legal duty to act primarily for another's benefit in a position of trust, good faith and responsibility, e.g. trustee, attorney-in-fact, custodian.
Power of Attorney: A written legal document that gives a person (the agent or attorney-in-fact) full legal authority to act on behalf of another (the principal – person granting the power). If the authority is to act for the principal in all matters, it is a General Power of attorney. If the authority granted is limited to certain specified things, it is a Special Power of attorney. If the authority granted survives the disability of the principal it is a Durable Power of attorney.
Durable Power of Attorney for Finances: A written legal document which allows one person (the principal) to authorize another person (the attorney-in-fact or agent) to act on his or her behalf with respect to financial matters, property management and other affairs; durable means it remains in effect during a subsequent disability or incapacity of the principal.
Durable Power of Attorney for Health Care: A written legal document which grants decision-making powers related to health care to an agent; generally provides for approval or removal of a physician, the right to have the incompetent patient discharged against medical advice, the right to medical records, and the right to have the patient moved to another medical facility or to engage other medical treatment.
Living Will: A document, directed to your physician, in which you state the level and extent to which certain life-prolonging measures are to be taken; defines your "right to die" — states that you do not want to have your life artificially prolonged by modern medical technologies. You can specifically define the means which you do want used or do not want used.
Incapacitated: A person who is legally incapable of managing his or her own business affairs. A person may be permanently or temporarily incapacitated. A probate court usually decides if a person is incapacitated or not. "Incapacitated" is often used interchangeably with "incompetent."
Business Concepts
Business Succession: A term used to describe transfers of asset ownership through inheritance, gifting, preferential sale, or other means that fulfill the wishes of the person(s) with present ownership of the assets.
Buy-Sell Agreement: An agreement between the owners of a business that provides that the interest owned by one who dies shall be sold to and will be purchased by the surviving co-owners or by the entity itself at a value or formula previously agreed upon by the parties and stipulated in the agreement. Also applies to buyout arrangements between owners.
Sole Proprietor: This is the simplest form of business organization, which in itself can be an important benefit. A business or professional practice carried on as a sole proprietorship exists only as a part of the owner. The business ends, for all intents and purposes, when the sole proprietor dies. A major disadvantage of a sole proprietorship is personal liability for the debts and obligations of the business. Therefore, the business provides no protection to the proprietor's nonbusiness assets. In terms of taxes, when a sole proprietor calculates personal taxable income for the year, he or she must add in any profit, or subtract any loss, generated from the sole proprietorship. This is included in Schedule C of Form 1040. As a general rule, a sole proprietor is also liable for self-employment tax.
Partnership: A form of business organization formed by two or more owners, known as partners. Generally, partnerships afford a great deal of flexibility in allocations of income, deductions among partners, and gains and losses; these areas are determined by the partnership agreement. Business owners can address the problem of unlimited personal liability of partnerships. A partnership is not a taxable entity in itself; it's a conduit — it passes income and other items directly through to the partners, who then report their distributive shares on their personal income tax returns. Because partners are not considered to be employees of a partnership, they are not eligible to receive tax-favored employee fringe benefits. Like sole proprietors, they generally must pay for such items as medical and life insurance with after-tax income.
General Partnership: A partnership that has only general partners and no limited partners. Each partner is fully liable for all partnership debts and there is no limited liability.
Limited Partnership: Form of partnership composed of both a general partner and a limited partner; the limited partners have no control in the management of the company and are usually financially liable only to the extent of their investment in the partnership.
Limited Liability Company (LLC): Most states have enacted laws allowing a new form of entity — the Limited Liability Company (LLC) or the Limited Liability Partnership (LLP); LLCs are available for most businesses; LLPs are designed for licensed professional practices; they combine the limited liability advantages of a corporation with the tax advantages of a partnership.
Corporation: A corporation is a form of business organization where the owners, known as stockholders, are considered by law to be separate from the corporation. Because a corporation is a separate entity, the personal assets of its shareholders cannot be taken in payment of corporate debts.
C Corporation: Unlike sole proprietors or partners, shareholder-employees of a C Corporation may receive many fringe benefits, such as medical coverage and group-term life insurance from the corporation on a tax-advantaged basis. The main drawback is that corporate income (after allowable deductions) is taxed once at the corporate level and again at the individual shareholder level when distributed as a dividend. The shareholder's liability is limited to the amount invested in stock and any loans made to the corporation. Another advantage is that ownership can be more freely transferred in the form of stock.
S Corporation: An "S" corporation is a corporation that has made an election to have its income, deductions, capital gains and losses, charitable contributions, and credits passed through to its shareholders. In some respects, S corporation employee owners are treated like partners in a partnership. Each shareholder takes into account his or her pro rata share of income, loss, deductions, or credits that the corporation has. Although shareholder-employees of S corporations are limited in the amount of fringe benefits that they can receive on a tax-advantaged basis, there are other advantages. Distributions, for example, are not subject to self-employment taxes. Total annual income tax can be reduced by allocating it to multiple shareholders. This can be especially effective in compensating individuals other than a spouse. Perhaps even more importantly, income earned by an S corporation generally is taxed only once, as compared with C corporation income that is taxed twice. In addition, S corporations provide both limited liability and the basic tax advantages of the loss pass-through and a single level of tax on business practice earnings. To be eligible to make the election, a corporation must meet certain requirements as to kind and number of shareholders, classes of stock, and sources of income.
Property Concepts
Fee Simple Ownership: Outright ownership of property with absolute right to dispose of or gift it to anyone.
Joint Tenancy with Rights of Survivorship (JTWRS): Two or more people take title to the same property and simultaneously each owns 100 percent of the property, or has full rights to the property. At the death of one joint tenant, his or her share immediately transfers to the ownership of the survivors by operation of law.
Tenants In Common: A form of asset ownership in which two or more persons have an undivided interest in the asset; the ownership shares are not required to be equal. The owners can own various percentages of the whole property, unlike joint tenants which each own an equal share. When one owner dies, his or her share does not "automatically" go to the other owners — tenants in common do not have a survivorship provision like joint tenancy.
Partition: The judicial separation of interests in property of joint or tenants in common owners so each may take possession, enjoy, and control his or her share of the property.
Community Property: Some state laws require that all assets acquired during a marriage belong equally to both spouses, except for gifts and inheritances given specifically to one spouse. Ten states (Alaska, Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington, and Wisconsin) use the community property system to determine the interest of a husband and wife in property acquired during marriage.
Separate Property: In community property states, all property which is not held commonly by a married couple is considered separate property. In general, it is property owned by one spouse in which the other spouse does not own an interest.
Beneficiary: An individual or trust which receives benefits under a will, insurance policy, retirement plan, annuity, trust, or other contract.
Per Stirpes: A way of distributing an estate so that the surviving descendants will receive only what their immediate ancestor would have received if he or she had been alive at the time of death. Common terminology — by right of representation; this is the most common way of distributing an estate such that if one of the children has predeceased the parents, his or her children share equally in that child's share of the estate distribution. This term is often summarized by the phrase, "if the parent is dead his children stand in his shoes" e.g., Parent A had children B and C; Child B had one child B1 and Child C had two children C1 and C2. If A had in his will that his property be divided by per stirpes ("by right of representation"), and Child B and C's children C1 and C2 were survivors, then B would receive one-half and the children C1 and C2 would split the other half (¼ to each). If the property had been divided per capita, than all would receive equal shares of one-third each.
Per Capita: An uncommon method of distributing an estate such that all of the surviving descendants share equally in the property; also known as pro rata. In example above, Child B would inherit 1/3, Grandchild C1 would inherit 1/3 and Grandchild C2 would inherit 1/3.
Life Estate: The right to receive all benefits from a property during one's lifetime. The person with the life estate doesn't own the entire property; when he or she dies, the property is not included in his or her estate.
POD Account (Payable on Death): A bank account that is designed to avoid probate. It is a contract between the bank and the account holder guaranteeing that, upon the account holder's death, the bank will pay the balance of the account to whomever is designated to receive the account.
TOD Account (Transfer on Death): A brokerage account that is designed to avoid probate. It is a contract between the brokerage firm and the account holder guaranteeing that, upon the account holder's death, the brokerage firm will pay the balance of the account to whomever is designated to receive the account.
Trust Concepts
Trust: A legal arrangement in which the grantor gives fiduciary control of property to the trustee which is held and managed for the benefit of the beneficiaries.
Grantor: The person who establishes a trust; also called the settlor or trustor.
Trustee: An individual or organization which holds or manages and invests assets for the benefit of the beneficiary.
Beneficiary: An individual who receives benefits under the trust.
Trust Corpus: The term used to designate the body of assets placed in a trust. The trust holds title to all property included in the corpus.
Revocable Living Trust (RLT): A written legal document into which you place all of your property, with instructions for its management and distribution upon your disability or death. The trust can be changed after it is established. Assets can be added or removed from the corpus of the trust, the beneficiaries can be changed, and other changes including termination of the trust, are allowed.
Inter Vivos ("Living") Trust: A type of trust created during the settlor's lifetime.
Testamentary Trust: A trust established after the death of the grantor under the provisions of the grantor's will.
Pour Over Will: This is a will used to transfer (pour over) into a trust any property that is left in a person's estate after death.
Charitable Remainder Trust: A trust used to make large donations of property to a charity so the person making the gift or donation can obtain tax advantages. In a charitable remainder trust, the donor reserves the right to income from the trust property during his/her life or some other specified time period, and when the agreed period is over, the property goes to the charity.
Irrevocable Life Insurance Trust (ILIT): A type of irrevocable trust used to hold life insurance. When a life insurance policy is held in an insurance trust, it is protected from estate taxes when the insured dies, provided the trust is established properly, managed properly, and the insured does not retain any "incidents of ownership."
Crummy Trust: A provisions added to an ILIT granting the beneficiaries a limited power to withdraw income or principal or both to convert a future interest to a present interest; makes grantor's contributions to the ILIT qualify for the gift tax annual exclusion. This power is exercisable during a limited period of time each year and is non-cumulative. The power of withdrawal is generally limited to the amount excludable from gift tax liability under the annual gift tax exclusion or to the greater of $5,000 or 5 percent of the trust property.
Tax Concepts
Fair Market Value: The price at which an asset can be sold from a willing buyer to a willing seller.
Gift: A voluntary transfer of property for which nothing of value is received in return. If the IRS is to recognize a transfer as a gift, the donor must unconditionally transfer all title and control of the property to the recipient at the time the gift is given.
Donor: A person who makes a gift.
Donee: A person who receives a gift.
Annual Exclusion: The amount of property the IRS allows a person to gift to another person during a calendar year before a gift tax is assessed and/or a gift tax return must be filed; the amount is currently $12,000 per donee each year. The amount is increased periodically reflecting the cost of living. There is no limit to the number of people you can give gifts to which qualify for the annual exclusion. To qualify for the annual exclusion, the gift must be one that a recipient can enjoy immediately and have full control over.
Capital Gain or Capital Loss: The profit or loss from the sale of a capital asset.
Tax Basis: A tax term, which refers to the original or acquisition value of a property, used to determine the amount of tax that will be assessed. The basis is deducted from the sales price of the property when it is sold to determine the profit or loss.
Step Up In Basis: The tax basis of appreciated property received due to the death of a decedent is "stepped up" to the market value of the property at the decedent's death. The result is a substantial tax savings upon the subsequent sale of the appreciated property. In effect, the basis in this property is deemed to be "stepped up" and does not reflect the decedent's original cost basis for determining applicable capital gains tax on the sale of the property.
Installment Sale: A sale in which taxable gain is recognized over a number of years as the payment for the property sold is received.
