Business Succession Planning

By: Clayton Walker, J.D.

Business succession planning concerns transferring business control to another person or business entity. Maximizing value from the business frequently involves minimal disruption to the business operations. Proper planning can also result in enhanced valuation and after tax results.


Business Succession Planning -- It's For the Children
Business Succession Planning is like Climbing.

Why Engage in Business Succession Planning?

There are a few key reasons for doing exit planning. A good plan should provide for: (1) owner liquidity; (2) tax deferral or minimization; (3) business continuity and (4) fund future family endeavors. .


If the business does not represent the bulk of your assets, transferring their business to the next generation may be easy. But many business owners, their main asset is their business. In these cases business value maximization, liquidity and cash flow may be determitive factors.

Planning for Estate Taxes

Even when the business owner’s objective is transferring ownership to family members, a systematic plan of gifts or sale of stock in the family business from the owners to the successors over a period of years will benefit both generations. Without a plan in place, unexpected events, including death or disability of the owner, may have dramatic consequences to retained value.


A business with moderate value (those valued over $5,250,000 for unmarried business owners and over $10,500,000 for married owners) may also be subject to the estate tax. A client whose estate consists primarily of a family-owned business generally want to retain the value and viability of the business for their heirs; and still not face the danger that the heirs may face a fire sale to pay the estate tax. This concern exists because federal estate taxes in 2013 have a rate of 40% for taxable estates in excess of $5,250,000 for single taxpayers ($10,500,000 for married couples who jointly own their assets). This tax burden can destroy the business value to your heirs.


Many businesses fail when the heirs can’t both keep the business running and pay the estate taxes. One solution is the use of life insurance and life insurance trusts. They are designed to provide liquidity when the business needs it most and avoid a forced fire sale of the business to pay the estate tax.


Ways an Owner Can Exit A Business

Owners may exit a business in basically three ways. The simplest is merely selling the busienss either to a third party, an insider or to an employee stock ownership plan (ESOP). A second is to transfer the business by way of gift, sale or GRAT, normally to family members. The last is the winding up the affairs and shutting down.

Selling the Business

If you don’t have a buyer in mind, you might simply turn to a business broker. The deal itself could be structured in a variety of ways.. When purchasers want to operations they can either structure the transaction as a stock deal or asset purchase. The assets either way consist of things like customer lists, software, equipment, trade-secrets, the trade name of the business, its website or other digital assets, leases, customer contracts, real property, workforce in place, operations manuals and nearly anything else you can describe and value. A sale may involve a single payment or a series of payments over time. Some deals involve staging of transfer over a period of time.


If you don’t control the business yourself you should have Buy-Sell Agreements with the other owners to reduce the confusion as to valuation procedures and control. This is another area that is commonly coordinated with life insurance or disability insurance to provide liquidity.

Helping Employees Buy Your Business by
Creating an ESOP

A business owner can create an Employee Stock Ownership Plan (ESOP) to buy the company. The basic plan is to transfer the owners stock to the plan in exchange for money. The plan gets the money from a lender using the stock and corporate assets as collateral. The ESOP is a special recognized creation of the tax code as a tax qualified defined contribution benefit plan. The ESOP is a very flexible tool that provides liquidity for shareholders, continuation of the business, raising working capital for the business, and charitable giving all while reducing taxes. The ESOP unlike other employee benefit plans hold just the stock of your business.

Selling and Gifting Your Business

Another way to transfer a business is to sell the business to family members on a loan, and then forgive parts of the loan periodically. The IRS allows you to use really low interest rates, thereby minimizing income tax effects. The IRS also allows you to give significant amounts annually without gift or estate tax effects.


You can sell on an Installment Note sale to an Intentionally Income Tax Defective Grantor Trust (a.k.a. IITDGT) or to make annual gifts to an IITDGT. I know defective things seem like bad things; but, in this case it can be a useful tool. Basically there has been for many years a distinction between how the tax code and the estate tax code defines who pays taxes on something that is in a trust. If the trust is defective for getting the income out of your hands for tax purposes we call the trust defective. This doesn’t mean the trust was not effective of eliminating the asset from your estate for estate tax purposes. This allows a person to give away an asset and then continue to pay the taxes on the asset given away to further reduce the taxable estate. This improves the tax efficiency of what was given away.


Another planning tool is the Self Cancelling Installment Note (SCIN). You use a SCIN when selling an asset like the interest in your business or real estate. The SCIN is a lot like an annuity or an installment sale. This tool is most effective when transferring value from an older person to a younger person. By providing for note forgiveness at the seller’s death you reduce the liquidity issues at death and provide for a discounted business valuation.


Grantor Retained Annuity Trusts (GRATs)

When you want to keep most of the income from the business you might employ a Grantor Retained Annuity Trust (a.k.a. GRAT). Using this tool you retain an income interest off the business that you put into the trust. Trusts can keep the terms of the deal private and may protect against creditor claims.


When you set up the GRAT you transfer your stock or business to an irrevocable trust. You name a trustee other than yourself. The trust provides from the outset that you get the earnings for a certain number of years. This is called the retention period. The annuity can either be a fixed value or a specific portion of the assets initially contributed.


If the trust doesn’t have the income to pay in a given year the trust must pay from the principal the specified annuity amount. When the retention period is over, the remaining assets, along with all the appreciation, passes to the trust beneficiaries.


On funding the GRAT, the IRS treats it as a gift to the trust beneficiaries. The IRS lets you reduce the gift value by the value the IRS determines you retained in the annuity. The discount is affected by several factors, including: the monthly required IRS interest rate, your age, how long you will receive an annuity, and whether or not the trust beneficiaries are your family members.


You win the grand prize if you survive the annuity term. None of the assets you transferred to the trust will be subject to federal estate tax when you die.

Closing Up Shop

Lastly, you can simply close up shop, cease all further business transactions and sell any assets of the business. When you do this you’ve settled for liquidation value and likely have left a lot of value on the table.  Business Succession Planning with a business tax attorney can help you maximize the return on your years of investment.

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