Are you a doctor with your own practice? Your practice at your private clinic or a co-owned clinic usually classifies as a small business. You have certain investments in the property that includes equipment, interior decor, staff and more. Your patients bring you the profit that usually goes into paying for your investments, i.e., the returns of your investment. It surely makes you the owner of a successful small business.
Even the best doctors can sometimes be bad business planners
It is true that businesses take up a lot of time and effort when they are nascent. As a result, when the company is running smoothly and is ready to expand, business owners rarely pay enough attention towards estate planning that involves their business or buy-sell agreements that define a future for their business. People do not like to think of a time when they are likely to leave the company, and that is a fact for almost all physicians in the USA. Although 90% doctors have Advance Medical Directive or Do Not Resuscitate documents prepared beforehand, they rarely have any interest in estate planning for business owners.
Take the first step: find a descendant
The first solution comes when you decide if you want to keep your business in your family. If there are other doctors in the family, then planning a smooth and tax deducted transfer of the real business property to the family member makes more sense. For example – a general physician has his own clinic people know about. His son is studying to be a pediatrician. If his son just starts his own private practice from his father’s chambers, he will be able to utilize his father’s patient networks. He will also be able to save a lot of rent or initial investment he would otherwise be making if he had to get his own place. Thus, doctors with other doctors in their immediate families often look for amicable ways of transferring their real business property to their spouse, next generation or other descendants.
In case you decide to transfer your business to the next generation or another member of your family, find out if they are at all interested in the preservation of the real business property. There is a high risk that works here. Personal practices of doctors depend upon their experience and popularity. Upon the death of such an individual small business owner, their business is likely to lose value. The stock prices will fall and may even become worthless upon the demise of the owner. However, since the fair market value depends on the evaluation of the business on the very day of the owner’s death, IRS may impose a considerable amount of capital gains tax on the beneficiary.
Always prepare for the worst and hope for the best
If you think that your practice will lose popularity and profit immediately after your death, you should reduce the risk of an imposing capital gains tax on your surviving family. You can document the plan of your business and the characteristics of your business. It will help to limit the transferability of your business. You should try and provide limited value to your business and prove so to the IRS to avoid the implication of estate tax on a company that will no longer exist.
Sect 6166 is the miracle all small business owners hail
Once you decide to leave your practice to a descendant, you can include your closely held business in you gross estate. Yes, this will induce a huge tax liability on the executor and the executor will likely not be able to pay it all at one go. Nonetheless, your executor will not have to sell off the business for peanuts just to stay afloat either, if they opt for Section 6166. The Internal Revenue Code provision allows all qualifying estates to distribute their estate tax over the next 14 years. Initially, the federal tax is due after nine months of the owner’s death, but Section 6166 of the IRC buys the decedent an extra 14 years to pay the taxes for the business property.
Know before you agree to it
Just like everything good, this also comes with certain conditions. Your business can qualify for Section 6166 only if at least 35% of the adjusted value of the gross estate includes an interest in the closely held company. If the decedent has interest in two or more businesses, the IRC can view it as a combination of both that meets that 35% test. It is only applicable if the decedent owned at least one-fifth or 20% of each of the businesses at death. Any and all small businesses with the following characteristics can potentially qualify for Section 6166 –
- A sole proprietorship or a sole trader
- A company in partnership with 45 or fewer partners
- A business in partnership, where at least 20% of the total partnership interest is a part of the gross estate
- Stock in a corporation with a maximum of 45 shareholders
- Share in an organization, where at least 20% of the voting stock is a part of the gross estate
All doctors as owners of small businesses should note that if their family members own shares of their “corporation” (practice), IRS will treat the situation like the stocks belong to the decedent himself. It is an example of Attribution Rules that help the estate meet the 45-owners or 20%-inclusion test.
Is it a pro or just another con?
As per the section 6166, your descendent can defer the estate tax by five years. However, they need to pay the interest on the tax during those five years. The estate tax is usually paid in a maximum of 10 annual installments, and they need to clear the first installment on the fifth anniversary of the tax return due date. When you elect Section 6166 treatment of your business property, you automatically empower the IRS to impose a lien on your property until your descendant pays the final installment of estate taxes.
While not having a buy-sell agreement or an estate plan without a business plan is extremely risky, electing Sec 6166 without know the implications can be more perilous. We want your property to be safe and for it to provide financial security to your family even after you are gone. Beam a Life can help you make an estate plan that consists of working business plans and tax plans to help you and your family save more! To find out everything about estate planning and tax planning, check out https://beamalife.com/ today!