What Is the Qualified Family-Owned Business Interest Deduction?

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 What is a Business Tax?

In general, all businesses are required to pay some form of a tax. The amount of taxes which are paid by a business and the type of taxes and rates that are applied will depend on the particular type of business.

For example, laws governing small business tax will be different from the laws that govern large corporations. Business taxes are important for the revenue of each state and the payment of those taxes helps to establish the business’ reputation and legitimacy in the community.

All business owners are required to be aware of their tax obligations and when those obligations are due. If a business owner does not pay their tax payments when they are due, there may be excessive fines and penalties. The failure to pay business taxes can negatively affect the way in which markets perceive the business.

What are the Different Types of Business Taxes?

There are four basic categories of business taxes. These categories are modeled after the structural formation of the business.

As previously noted, the details of the taxation and the rates for each type of business will differ depending upon the region or state. The basic categories of business tax include:

  • Income tax;
  • Self-employment tax;
  • Employment tax; and
  • Excise Tax.

Income taxes are business taxes which are based on the yearly income of that business. The form of tax and the amount which is required to be paid will depend on the type of business.

The self-employment tax, also called the SE tax, applies to individuals who are self-employed. These taxes related mostly to Social Security and Medicare issues.

Employment tax is a tax which is levied on organizations that have formal employer-employee relationships. Employers are required to withhold employment taxes from their employees’ pay.

An excise tax is a tax which is imposed on a business that:

  • Makes or sells certain types of products;
    Operates specific business types;
    Uses certain products, equipment, or facilities; or
    Receives payment for specified services.

There are several subcategories of excuse taxes, including:

  • Environmental taxes;
    Fuel taxes; and
    Communications/transport taxes.

A business may be required to pay multiple different taxes for a single year. If the business changes in any way, they may be required to make necessary adjustments to their taxes.

What are Tax Deductions?

A tax deduction is a reduction of income which can be taxed by the government. The purpose of a tax deduction is to decrease an individual’s taxable income.

A tax deduction also decreases the amount of income tax that an individual taxpayer owes to the federal government. There are hundreds of ways for individuals to reduce their taxable income, however, many individuals do not know about them or how to take advantage of them.

What Types of Tax Deductions are There?

There are two main categories of tax deductions, a standard deduction and an itemized deduction. The standard deduction, as the name implies, is a standard dollar amount which is set by the IRS every year.

An itemized deduction depends on the amount which is being declared in each category. The types of deductions include:

  • Casualty and theft losses;
  • Charitable contributions;
  • Medical and dental expenses;
  • Union dues;
  • Home office expenses;
  • Gambling losses;
  • Interest paid on investments;
  • Property tax;
  • Personal property tax; and
  • Job-related expenses.

What Types of Tax are Deductible?

Generally, any tax which is not a federal income tax, such as excise taxes, transfer taxes, and luxury taxes, is deductible from an individual’s gross income. Foreign, state, and local income taxes are all deductible.

One major tax which is not deductible from an individual’s gross income is a sales tax of any kind. A business may deduct a sales tax from its gross income.

In the year following taxation, state income taxes are deductible because it is not possible for the taxpayer to know their correct taxation amount until the year after the taxes are paid.

What is an Interest Deduction?

An interest deduction is a deduction which is allowed by the Internal Revenue Service (IRS) which is taken because the taxpayer was forced to pay interest on a particular debt which they incurred. In general, interest is deductible.

One major exception to this rule is that consumer interest is not deductible. In a certain sense, the exception swallows the main rule, due to the fact that credit card interest payments and the like as well as other similar interest payments are not deductible from an individual’s gross income.

What is the Qualified Family-Owned Business Interest Deduction?

The Taxpayer Relief Act of 1997 provided the Qualified Family-Owned Business Interest (QFOBI) deduction. This deduction was subsequently amended by the Internal Revenue Service (IRS) Restructure and Reform Act of 1998.

The deduction was repealed when the Economic Growth and Tax relief Reconciliation Act of 2001 was passed. In addition, the estate tax and generation-skipping tax which was scheduled for 2010 was also repealed.

The QFOBI was repealed because it was deemed unnecessary due to the larger exemption amounts as well as the decrease in estate tax rates between 2001 and 2011. It was also repealed because it was regarded as a complex deduction which placed a burden on the heirs.

The QFOBI was reinstated in 2010. This deduction is a way for individuals to reduce their estate tax by permitting them to deduct a qualified family-owned business interest from their gross estate.

How Can I Qualify for the Deduction?

In order to qualify for the qualified family-owned business interest deduction, and individual must meet certain requirements, including:

  • The decedent or family members were the owners and active participants in the business for a minimum of five out of the previous eight years;
  • The business interest comprises a minimum of 50 percent of the adjusted gross estate of the decedent after accounting for:
    • deductible debt;
    • expenses; and
    • taxes;
  • The decedent and the decedent’s family were the owners of at least 50 percent of the business; or
    • members of two families owned 70 percent, while the decedent and the decedent’s family owned 30 percent; or
    • members of three families owned 90 percent, while the decedent and decedent’s family owned 30 percent;
  • The decedent was a citizen or a resident of the United States; and
  • The business is or was located in the United States.

There will be more estate taxes imposed, however, if, within a time frame of 10 years following the decedent’s death and prior to the qualified heir’s death, the heir does not maintain an active participation in the business for three years in any eight year period of time.

What is the Amount of the Deduction?

Pursuant to the Taxpayer Relief Act of 1997, the amount of the qualified family-owned business interest deduction was set at $675,000. If an individual passed away in 2001, the amount of the deduction was $625,000. The deduction could not exceed $1.3 million when it was added to the applicable exclusion.

In 2004, the exclusion amount rose to $1.5 million. In other words, the family-owned business deduction would allow a family-owned business, such as a farm, to pass without estate tax to the heirs if the value does not exceed the exclusion amount.

Should I Seek Legal Advice Regarding the Qualified Family-Owned Business Interest Deduction?

Yes, it is essential to have the assistance of an estate attorney for any issues or questions you may have related to the qualified family-owned business interest deduction.

If you are interested in reducing your estate taxes, your attorney can advise you on the various ways in which that may be accomplished, including the qualified family-owned business interest deduction.

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