BUSINESS SUCCESSION PLANNING BASICS

Business Succession Planning

When developing a succession plan for your business, you must make many decisions. Should you sell your business or give it away? Should you structure your plan to go into effect during your lifetime or at your death? Should you transfer your ownership interest to family members, co-owners, employees, or an outside party? The key is to develop a succession plan that integrates your personal financial planning objectives, your estate plan, your business plan, and your overall business transition plan.  When these factors are all working together, your “Success in Succession” is optimized.  We recommend you work with a coordinated, qualified team of advisors to develop and execute such a strategy.

Selling your business

Selling your business outright

You can sell your business outright, choosing the right time to sell — now, at your retirement, at your death, or anytime in between. The sale proceeds can be used to maintain your lifestyle, or to pay estate taxes and other final expenses. As long as the price is at least equal to the full fair market value of the business, the sale will not be subject to gift taxes. But, if the sale occurs before your death, it may result in capital gains tax.

Transferring your business with a buy-sell agreement

A buy-sell is a legally binding contract that establishes when, to whom, and at what price you can sell your interest in a business. A typical buy-sell allows the business itself or any co-owners the opportunity to purchase your interest in the business at a predetermined price. This can help avoid future adverse consequences, such as disruption of operations, entity dissolution, or business liquidation that might result in the event of your sudden incapacity or death. A buy-sell can also minimize the possibility that the business will fall into the hands of outsiders.

The ability to fix the purchase price as the taxable value of your business interest makes a buy-sell agreement especially useful in estate planning. Agreeing to a purchase price can minimize the possibility of unfair treatment to your heirs. And, if your death is the triggering event, the IRS’ acceptance of this price as the taxable value can help minimize estate taxes.

Additionally, because funding for a buy-sell is typically arranged when the buy-sell is executed, you’re able to ensure that funds will be available when needed, providing your estate with liquidity that may be needed for expenses and taxes.

Private annuity

With a private annuity, you transfer your ownership interest in the business to family members or another party (the buyer). The buyer in turn makes a promise to make periodic payments to you for the rest of your life (a single life annuity) or for your life and the life of a second person (a joint and survivor annuity). Again, because a private annuity is a sale and not a gift, it allows you to remove assets from your estate without incurring gift or estate taxes.

Until 2006, exchanging property for an unsecured private annuity allowed you to spread out any gain realized, deferring capital gains tax. IRS regulations proposed that year have effectively eliminated this benefit for most exchanges, however. If you’re considering a private annuity, be sure to talk to a tax professional.

Self-canceling installment note

A self-canceling installment note (SCIN) allows you to transfer your interest in the business to a buyer in exchange for a promissory note. The buyer must make a series of payments to you under that note, and a provision in the note states that at your death, the remaining payments will be canceled. Like private annuities, SCINs provide for a lifetime income stream and they avoid gift and estate taxes. But unlike private annuities, SCINs give you a security interest in the transferred business.

Gifting your business

If you’re like many business owners, you’d prefer to have your children inherit the result of all your years of hard work and success. Of course, you can bequeath your business in your will, but transferring your business during your lifetime has many additional personal and tax benefits. By gifting the business over time, you can hand over the reins gradually as your offspring become better able to control and manage the business on their own, and you can minimize gift and estate taxes.

Gifting your business interests can minimize gift and estate taxes because:

  • It transfers the value of any future appreciation in the business out of your estate to your heirs. This can be especially valuable if business growth is expected.
  • Gifts of $15,000 (in 2018) per recipient are tax free under the annual gift tax exclusion.
  • Aggregate gifts up to $11,180,00 (in 2018, $5,490,000 in 2017) are tax free under your lifetime exclusion.
  • Partial interest gifts, as with GRATs, GRUTs, and FLPs, may be valued at a discount for lack of marketability or restrictions on transferability.

Gifting your business using trusts

You can make gifts outright or use a trust. You can even structure a trust so that you keep control of the business for as long as you want. You can establish a revocable trust, which will bypass probate and allow you to change your mind and end the trust, or an irrevocable trust, such as a grantor retained annuity trust (GRAT) or a grantor retained unitrust (GRUT) that can provide you with income for a specified period of time and move your business out of your estate at a discount.

Gifting your business using a family limited partnership

You can transfer your business interest using another entity, such as a family limited partnership (FLP). An FLP is a limited partnership formed to manage and control a family business. You (and your spouse) can be the general partners, retaining control of the business itself and receiving income from the business, while your children can be limited partners. By transferring the business to an FLP, you may be able to use valuation discounts and substantially reduce the value of the business for tax purposes by making annual gifts to the limited partners.

The key is to pick the best plan for your circumstances and objectives, and to seek help from a qualified team of advisors to help you execute the plan.

Common business succession planning objectives

  • Ensure smooth, seamless transfer of ownership
  • Transfer business to next generation
  • Ensure business continuity
  • Retire with income source
  • Minimize gift and estate taxes

 

DID YOU KNOW SOME OF THE TAX LAW PROVISIONS ARE TEMPORARY, OTHERS PERMANENT?

The Tax Cuts and Jobs Act (TCJA): Which Provisions are Temporary and Which are Permanent?

The Tax Cuts and Jobs Act (TCJA) includes a number of important tax changes for individuals and businesses. However, it’s often difficult for advisors and investors to keep track of which changes are permanent and which are scheduled to expire at the end of 2025 – unless Congress extends them.

Here’s summary to help you keep track of the permanent vs. temporary changes as the tax law stands today.

Permanent Provisions

These changes take effect for tax years beginning in 2018 unless otherwise noted:

For Individuals

  • No deductions for alimony payments required by post-2019 divorce agreements.
  • No more reversals of Roth IRA conversions.
  • Repeal of the penalty for failure to have “minimum essential coverage” under the Affordable Care Act for months beginning in 2019 and beyond.
  • Tax-free distributions of up to $10,000 annually from Section 529 accounts to cover qualified K-12 school expenses at public, private or religious schools.
  • Elimination of favorable treatment under Section 1031 for exchanges of personal property.
  • No more charitable write-offs for a payment to a college if the payment entitles you to buy tickets to athletic events of the college.

For Businesses

  • Flat 21% federal income tax rate on corporations.
  • Elimination of the corporate alternative minimum tax (AMT).
  • More-generous rules for first-year Section 179 depreciation write-offs.
  • More-generous depreciation deductions for passenger vehicles used for business (cars, light trucks and light vans).
  • Faster depreciation for some real property and farming machinery and equipment.
  • Expanded eligibility to use cash-method accounting and simplified inventory accounting procedures.
  • Favorable accounting method change for eligible construction companies with long-term contracts.
  • Elimination of favorable treatment under Section 1031 for exchanges of personal property.
  • Reduced or eliminated deductions for business entertainment and some employee fringe benefits.
  • Stricter rules on deducting net operating losses (NOLs).
  • Several provisions affecting S corporations, partnerships, and LLCs treated as partnerships for tax purposes, excluding the new deduction of up to 20% of qualified business income (QBI).
  • Self-created intangible assets no longer treated as capital gains assets. Applies to inventions; models and designs; secret formulas; and certain processes.
  • New three-year holding period rule before long-term capital gains treatment is allowed for partnership carried interests.
  • New $1 million annual limit on compensation deductions for amounts paid to principal executive officers.
  • New requirement, for tax years beginning after Dec. 31, 2021, for specified R&D expenses to be capitalized and amortized over five years, or 15 years if the R&D is conducted outside the United States.

Temporary Provisions

These changes take effect for tax years beginning in 2018, and expire at the end of 2025, unless otherwise noted:

For Individuals

  • Reduced federal income tax rates.
  • More-favorable alternative minimum tax (AMT) rules.
  • Expanded standard deductions.
  • Increased child tax credit (up to $2,000 per qualifying child, with up to $1,400 that can be refundable), and higher income thresholds for the child credit phaseout.
  • Credit of up to $500 for dependents who aren’t qualifying children.
  • Lower income threshold for itemized medical expense deductions (scheduled to expire at the end of 2018).
  • Elimination of the phaseout rule that can reduce some itemized deductions for higher-income individuals.
  • 60% adjusted-gross-income limit for itemized deductions for cash donations to public charities.
  • Tax-free treatment for forgiven student loans due to death or disability.
  • Increased federal gift and estate tax exemptions ($11.18 million or effectively $22.36 million for married couples for 2018).
  • Deduction for up to 20% of qualified business income (QBI) from pass-through entities for noncorporate owners.
  • Elimination of personal and dependent exemption deductions.
  • Limitations on itemized deductions for home mortgage interest.
  • Limitation on itemized deductions for state and local income and property taxes.
  • Elimination of itemized deductions for miscellaneous expenses.
  • Elimination of itemized deductions and tax-free employer reimbursements for moving expenses (except for certain military personnel).
  • Elimination of itemized deductions for personal casualty and theft losses (except for losses incurred in federally declared disasters).
  • Elimination of itemized deductions for hobby expenses.*
  • Revised kiddie tax rate structure.*
  • Stricter deduction rule for nonwagering expenses incurred by professional gamblers (such as for travel and lodging).
  • Limitation on deducting large business losses recognized by individual taxpayers.

For Businesses

  • 100% bonus depreciation for qualified business assets (expires after 2022).*
  • Bonus depreciation with declining percentages for 2023 through 2026.*
  • New tax credit for employer-paid family and medical leave for payments made in tax years beginning in 2018 and 2019.*

* Indicates that this provision is not included in the “Protecting Family and Small Business Tax Cuts Act.”

In September, the House Ways and Means Committee introduced the “Protecting Family and Small Business Tax Cuts Act of 2018.” This bill would make the many temporary TCJA provisions permanent. House Republican leaders are expected to have trouble mustering the 216 votes needed to pass the measure. However, even if the measure passes the House, the Senate isn’t expected to take up the legislation before the November elections.

Talk with Your Tax Professional 

These lists contain only the most widely applicable TCJA provisions; some changes are not included in the two lists. Optimized Business Transitions, LLC. is not a CPA or accountant. You should consult your tax professional who can provide details about the temporary and permanent TCJA changes that could affect your specific personal and business situation.