How Family Corporations Ease the Burden of Tax on Estates
When a man acquires property on account of years of hard work and labor, the tendency is he will strive to preserve the property for the benefit of his family. Filipinos are fond of buying real property as a legacy for their children. But is one actually free to plan and ensure that his assets will be enjoyed by those he chose even after his death? We have heard of stories of people amassing fortunes during their lifetime only to perish leaving their children with massive debts and liabilities to settle.
While the decedent who lived life prosperously rests in peace, those left behind claim that the government cashed in on the estate leaving nothing for them. Yet is it fair to point the finger at the government who enforced the tax or do we lay the blame on the decedent’s lack of foresight?
A considerable portion of a decedent’s estate is devoted for payment of estate taxes. Under present tax laws, when a person dies, his net estate is subject to estate tax which ranges from 0 percent to 20 percent, depending on the value of the net estate. Assets such as real property, shares of stock, bank deposits, and other registered or registrable properties cannot be transferred to the heirs unless a certification is obtained from the Commissioner of Internal Revenue showing that estate taxes have been paid.
In addition, estate taxes should be paid within six months from the time of death of the decedent. After this period, the heirs will be liable to pay on top of the 0-20 percent estate tax, a penalty equivalent to 25 percent – 50 percent of the amount due, as the case maybe; interest at the rate of 20 percent a year on any unpaid amount of tax from the date prescribed for payment until the amount is fully paid; and a compromise penalty as a form of extra-judicial settlement of the heir’s liability.
The imposition of the estate tax is justified based on the estate-partnership theory which provides that estate tax represents the share of the state as a passive and silent partner in the accumulation of property by the decedent. The state is regarded as an extraordinary compulsory heir of a decedent, practically taking precedence over all the legitimate heirs in the distribution of the decedent’s assets. Estate tax in effect allows the entry of the first stranger to the family’s exclusive property.
For example: A person dies leaving a net estate of P15 million. Should the heirs file the estate tax return within six months from the date of death of the decedent, they would have to pay a little over P2.2 million basic estate tax. However, should the heirs belatedly file the estate tax return after five years, the amount payable is estimated at P5 million.
Using the above example, it is certainly economical for the heirs to pay the estate tax right away. But what if the heirs do not have cash? Then again, even without delay the amount of P2.2 million is difficult to produce within just six months. The heirs would then have to immediately dispose of properties if only to avoid interest and penalties from setting in. But again, what if the estate consists of only one real property such as the ancestral home? Will the heirs be compelled to sell their ancestral home? Even so, what if the property is not sellable? It seems like the heirs are rapidly running out of options and if they fail to act promptly, they may find themselves eventually forfeiting the entire property in favor of the government.
It is therefore conceivable how hard-earned assets are washed-out by the occurrence of death. Thus, morbid as it may seem, a person must plan ahead of his death so that estate tax and other settlement expenses will not dissipate his wealth.
The creation of family corporations has often been resorted to by individuals whose foremost objective is to reserve the management of wealth within the family.
Private individuals have the legal right to forbid outsiders to come in and interfere with the management of the family’s assets, and much less share in whatever fortune has been brought about by the family’s collective efforts. A family is not prohibited from forming private corporations expressly limiting the shareholders to members of the same family for the purpose of effective property and asset management. The fact that a corporation is owned or controlled by one family will not give rise to the loss of its corporate personality and the piercing of its corporate veil.
The doctrine of piercing the veil of corporate fiction takes place only after the occurrence of fraudulent, illegal or criminal acts without which the distinct personality of the corporation is maintained notwithstanding that one family controls it.
Family Firms and Real Estate Planning
The following are features of a family corporation which makes it valuable for estate planning purposes:
Family corporations are permanent in nature. While a person dies, a corporation exists despite the incapacity of its stockholders. A corporation grants individuals privileges which they would not otherwise possess, the most important attributes of which are continued legal identity and indefinite succession under a corporate name. Death of the transferor of the asset becomes immaterial in relation to the property transferred. And so does estate taxes.
Transfer of property to a family corporation is tax-free. Generally, real property may be transferred to another either through sale, donation or succession. In all cases, the seller, donor or heirs will be exposed to tax at the rates of 6 percent or 0-20 percent as the case may be. On the other hand, a corporate structure enables individuals to transfer property away from the estate with minimal tax consequence. Parents may therefore invest their conjugal properties to a family corporation without having to pay heavy transfer taxes.
The Tax Code prescribes a tax-free method of conveying an individual’s properties to a corporation otherwise referred to as a tax-free exchange. The law provides that no gain or loss is recognized if a person exchanges his property for stock in a corporation where as a result of such exchange, said person, alone or together with others not exceeding four persons gains control of said corporation. Such being the case, a transfer of property away from one’s estate and in favor of a family corporation in exchange for shares of stock in the corporation legally avoids taxes on transfer of property, such as the estate tax.
Parents maintain effective control of the assets of the family corporation. In a conventional family corporation, the parents hold key positions in the corporation as members of the board of directors or as stockholders thereof. Despite the conveyance of property, the parents do not lose absolute ownership over the asset transferred in favor of the family corporation. As a member of the board of directors, parents would continue to have authority to determine policy and conduct the ordinary business of the family corporation and its assets. As stockholders, they possess among others, the right to vote at stockholders meetings, to elect and remove directors, to approve certain corporate acts and to adopt and amend or repeal the by-laws of the corporation.
Notwithstanding, the transfer, the parents may retain the power to control the management of their assets. In fact, upon transfer of property in favor of the family corporation, the parents begin to share the power of control over the property with their children without having to surrender absolute ownership before succession sets in.
Family members incur limited liability. A person who conducts his business through a sole proprietorship exposes himself to the risk of attachment and seizure of property for payment of personal liabilities. This is due to the unlimited personal liability of the sole proprietor. In a corporate set-up, the personal assets of stockholders cannot be held liable for corporate debts and liabilities.
Family corporations protects against the adverse tax consequence due to the appreciation in value of real estate. It is important to note that in case of the transfer of real property by way of succession, the liability for estate tax proportionately increases as the fair market value of the property appreciates.
If a person dies leaving an estate consisting of real properties, the basis for the estate tax shall be the current fair market value of the properties at the time if his death. Hence, if the decedent acquired a parcel of land in 1972 with fair market value of P1 million and dies in 2003 leaving the same parcel of land with an appreciated fair market value of P15 million, the basis for the estate tax will be the current fair market value of the property at the time of his death or P15 million.
The above principle does not apply when real property has been previously transferred to a family corporation pursuant to Section 40(C)(2) and (6)(c) of the tax code. In this case, instead of leaving real properties, the decedent leaves an estate consisting of shares of stock in the family corporation. Upon death, the transfer or conveyance of the shares of stock in the family corporation will be subject to estate tax based on the original acquisition/historical cost, which is the book value of the assets previously transferred by the decedent to the family corporation in exchange for the shares of stock.
Hence, if in 1998 a parent transfers a parcel of land with fair market value of P5 million in exchange for shares of stock in a family corporation and then dies in 2003 holding the shares of stock in the family corporation, the basis for the estate tax upon the transfer will be the book value of the shares in stock of the family corporation (P5 million) and not the fair market value of the property (P15 million) which carries the appreciated value (P10 million).
It may be inferred from the above that the transfer of one’s estate through the conveyance of shares of stock of a family corporation effectively safeguards the decedent against the appreciation in value of real estate which in turns prompts the imposition of the progressive rate of estate taxes.
It is noteworthy to remember that a taxpayer has the legal right to decrease the amount of what otherwise could be his taxes or altogether avoid them, by means which the law permits. He is free to plan ahead of time and use all available means within the bounds of law which will ensure that his assets are to be enjoyed by only those he chose. Note however that a corporation is relatively complicated in formation and management, for this reason it is deemed prudent for one to seek professional advice before implementing such estate plan.
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Robert G. Sarmiento Properties
Professional Affiliation :
Philippine Association of Real Estate Boards
Member, City of Taguig Real Estate Board 2016 – 2018
Real Estate Broker’s Association of the Philippines 2000 – 2015
President, Greenhills Chapter 2008, 2009
Philippine Association of Real Estate Boards
San Juan Mandaluyong Chapter 1998 -1999
PRC # 6569
PRC Lecturer’s License # 0294
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