Washington state grants estate tax relief if a decedent owns a qualified family-owned business interest (QFOBI) at the time of death and such property passes to a "qualified heir." A "qualified heir" includes the decedent's spouse, a lineal descendant of the decedent, the decedent's spouse or parent, the spouse of any such lineal descendant, or an employee active in the trade or business who has been employed by the business for at least 10 years prior to the decedent's death.
If the requirements below are met, there is a QFOBI deduction of up to $2.5 million against the Washington estate tax.
Washington QFOBI Deduction Requirements
The Washington QFOBI deduction is permitted if:
- The value of the QFOBI exceeds 50 percent of the decedent’s Washington estate, before applying the Washington applicable exclusion amount (which is presently $2.193 million);
- During five of the eight years preceding the decedent's death, the decedent or a member of the decedent’s family owned and materially participated in the business;
- The decedent's qualified heirs receive the QFOBI as an inheritance;
- The decedent was a U.S. citizen or resident; and
- The value of the decedent's interest in the qualified family-owned business is not more than $6 million.
For example, if a U.S. citizen decedent dies with a $10 million Washington estate which includes a $6 million business interest in which he or she served as president of the business, owned the business interest for the six years preceding death, and left the business interest equally to his or her three children, the decedent's estate would receive a QFOBI deduction of $2.5 million.
Notwithstanding any other deductions to the decedent’s estate, and after applying the Washington applicable exclusion amount of $2.193 million, he or she would have a Washington taxable estate of $5.307 million.
- Using the same example above, if the business interest was only worth $5 million, the decedent's estate would not be allowed the QFOBI deduction because the business interest did not exceed 50 percent of the decedent's Washington estate.
Because the QFOBI must exceed 50 percent of the decedent's Washington estate (before applying the Washington applicable exclusion amount), and because the value of the decedent's interest in the qualified family-owned business cannot be more than $6 million, the Washington QFOBI deduction is limited to estates of $11,999,999 or less.
Qualified Heirs Beware
While the decedent's estate is allowed the Washington QFOBI deduction if the above requirements are met, the qualified heirs must abide by certain rules in order to avoid having to pay back any estate tax savings, plus interest.
These rules require that for a period of three years following the decedent's death, the qualified heirs receiving the business interest:
- Must materially participate in the business;
- Cannot transfer the business interest to another party who is not a qualified heir or another current owner of the business;
- Must retain U.S. citizenship; and
- Cannot move the business out of the U.S.
Failing to meet these additional requirements during the three-year period results in the qualified heir being personally liable for an additional tax equal to the estate tax savings of the estate plus interest calculated from the date that the estate tax liability was due from the decedent's estate to the date of the qualified heir’s payment.
If more than one qualified heir receives a QFOBI, any heir who is no longer qualified will owe the additional tax due in a prorated portion of the tax savings based on the distribution of the QFOBI to all of the qualified heirs.
- For example, if a decedent's estate took the Washington QFOBI deduction, then a qualified heir decides to sell the business to an unrelated third party or move the business to Canada two years and nine months after the decedent's death. The qualified heir would then be liable to repay any of the decedent’s estate tax savings, plus interest.
- As another example, if four siblings receive an equal share of a QFOBI, then a sibling who fails to meet the requirements above will be personally liable for an additional tax equal to one-quarter of the estate savings.
Any additional tax is due within six months of the event which caused such tax to become due.
Weighing Business Decisions Against Tax Liabilities
While these limitations may seem problematic, the three-year period is measured from the date of the decedent's death and not when the qualified heirs receive the property, which can often take a year or two as the estate is settled and distributed. If a qualified heir is facing a business decision that could result in violating one of the conditions above, the decision should be weighed against the possibility of paying back the estate tax savings and interest.
For example, the Washington estate taxing savings from the QFOBI deduction on the largest taxable estate of $11,999,999 is roughly $500,000, plus any accumulated interest. If a lucrative opportunity arises to sell the business, the sales proceeds could outweigh the obligation of repaying estate tax savings and interest. Moreover, the sales price may also account for any amount of such estate tax saving and interest.
A planning consideration for those whose estates may be eligible for the Washington QFOBI deduction is whether to give a family-owned business equally to all heirs. If an heir has no interest in a family-owned business or perhaps is married to a non-U.S. citizen (and there is a potential for expatriation), it may be wise to consider giving that heir a different portion of the estate, if possible.
The Trusts and Estates attorneys at DWT are available to assist family-owned businesses, owners, and qualified heirs navigate the QFOBI deduction.