Once More Into The Breach

By Howard Muson

Supporters of estate tax reform—including Senator-turned-lobbyist Bob Packwood—are rallying their forces. What will they settle for?

When speaking of estate taxes, supporters of reform like to refer to “death taxes,” suggesting that the tax itself is a killer too—of successful businesses. Last year a coalition of some 80 trade associations and business groups came together and succeeded in getting legislation through Congress that was eventually killed by a stroke of the President’s pen. This year the Family Business Estate Tax Coalition comprises more than 100 associations, from the National Cattlemen to the National Retailers. They are digging in for a long fight.

“Generally, we’d all like to see the tax eliminated,” says Jamie Wickett, manager of legislative affairs for the National Federation of Independent Business (NFIB). “Stepping down from that, it’s just a question of what you think you can get this year, and the best way to go about that.” For NFIB, which represents 6,000 smaller businesses with average revenues of about $500,000 a year, estate tax reform is a top priority. “It’s what our members get more outraged over than almost any other government issue,” Wickett said.

Short of repeal of the estate tax, NFIB would like to see a major increase in the unified credit of $600,000 per decedent, and a major decrease in the tax rates, which go up to 55 percent in some cases. “If you have a business worth $2 million,” Wickett said, “probably an increase in the unified credit will take care of you substantially. If you have a business worth $200 million, that isn’t going to help you much. For one thing, the unified credit is phased out at $21 million.”

Larger businesses were disappointed by the bill reported out of conference committee last year, because it established a “cap” on the assets that heirs to a family business could exclude from tax. The total exemption per decedent under the bill came to $1.75 million—and each spouse in a family would have been entitled to it. The bipartisan bill introduced in March by Senator Trent Lott and Congressman Charles Grassley would establish a much higher cap—$8.5 million.

Former Oregon Senator Robert Packwood, now a lobbyist in Washington, acknowledged that grassroots support falls off the higher the cap is raised. In an interview with Family Business, Packwood, who represents six resource-based companies in the Northwest as well as other family businesses, said: “If we are successful in our lobbying, there will not be a cap. But I’m also aware that the higher you go up the income scale—$5 million, $10 million, $50 million, $100 million—the more people drop out. They say, ‘Okay, that takes care of me.’”

The fact that estate tax reform will be considered in the context of an overall tax package could also weaken the coalition’s focus. Packwood pointed out that the estate tax isn’t the top tax issue for most members of the coalition. “You have the truckers, for example, who place a higher priority on reducing gasoline and diesel fuel taxes. You have the retailers, for whom a higher priority is defeating Congressman Archer’s proposal for a consumption tax of 28 percent.”

Packwood’s clients want to make sure that, if Congress passes a preference for family businesses, the definitions of what is a “qualified family business” are entirely clear. For example, one commonly referenced requirement is that descendants and their heirs “materially participate” in the business. The IRS has defined material participation as spending 35 hours or more in the business. But Packwood asks what happens to operators of a lumber mill who own thousands of acres of trees. “You don’t spend all your time looking at your trees grow. It probably takes you 70 hours a week to operate the lumber mill and only 5 hours to manage your trees. But you own them both.”

Under another common provision, a company doesn’t count as a family business if 35 percent of its revenue is so-called passive income such as rent. “What do you do with a family business that for deliberate reasons has a holding company and, under it, two or three operating companies?” Packwood asks. “The family runs it, but all of the income flows up to the holding company. Is that going to be called ‘passive income?’”

In order to qualify for the exclusion, Packwood also noted, 50 percent of the value of the decedent’s estate must be in the business. “What happens to all the people who have been intelligently planning their estates for the last 20 years and passing on their stock to their children? They no longer own 50 percent of the business. They may be hoisted by their own petard.”

Packwood and his clients want to leave the IRS very little “wiggle room” in interpreting definitions of a qualified business. He says that there are already more than 100 cases in the courts that turn on the question of how material participation is defined.

NFIB agrees. “Certainly, we want the definitions to be as strong as possible, so family businesses do not end up mired in detail when trying to pass on the company,” Jamie Wickett said.

Packwood senses a growing momentum for reform. The Cox-Kyl bill to abolish the tax altogether is picking up sponsors every day. Attendance at gatherings of supporters is increasing. “Initially we had 30 to 35 people coming to the meetings. Now we have as many as 75 to 80. We’re so far ahead of where we were nine months ago. No one would have thought we could have gotten as far as we have already.”

A baseball family’s pre-emptive strike

The O’Malleys of Los Angeles are the most highly publicized recent example of how the prospect of paying estate tax can strike out a successful family business. The O’Malleys own what is, by all accounts, one of the best-managed and most valuable sports franchises in the country—the Los Angeles Dodgers. The franchise is known for its family-like atmosphere and its major contributions to the community in Southern California.

In January, Peter O’Malley, who took over in 1970 from his father, Walter, announced that the family plans to sell the franchise. One big reason was that major league sports teams today need to invest in things like high-tech stadium enhancements, luxury boxes, and multimedia deals, all of which require mega-financing. At a news conference, Peter, 59, commented that high-risk, global sports ventures would in the future be run exclusively by well-heeled corporations and investor groups, and that “family ownership of sports is probably a dying breed.”

But Peter said another major reason for the sale was the family’s need to diversify its assets. Most of the O’Malleys’ wealth is tied up in the franchise. Upon the deaths of the current owners, the heirs would have had to pay a 55 percent estate tax on assets over $5 million when the business was passed on—compared with a capital gains tax of 28 percent if the business is sold now. That might have led to a distress sale, at less than what the franchise is worth. “Call this a pre-emptive strike,” one sports lawyer said about the family’s decision.

Peter O’Malley, president of the company, shares ownership of the franchise with his sister, Terry Seidler. Peter and his wife, Annette, have three children. Terry and her husband, Roland, have 10. The sale will end 50 years of family ownership. -- H.M.

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Spring 1997

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