Putting “Success” in Your Succession Plan

Putting “Success” in Your Succession PlanBaylor

Legacies Newsletter

When you plan the transfer of family business from an older to a younger generation, how the older generation gets the value they deserve out of the business is an important question! The Haft family, owners of the multimillion dollar holding company that owns Crown Books and Trak Auto stores, is currently discussing this issue, among others, very publicly in the courts and newspapers.

There are nearly as many possible solutions to this aspect of succession planning as there are family-owned businesses. This article presents some ideas that can serve as a starting point for your personal planning discussions.

Possibly the simplest answer is just selling the business. You could sell it to family, employees, or some outside party. The major issues in this choice are properly valuing the business, finding a suitable buyer, and how you get paid. One common approach in selling the business is the installment sale, where the older generation receives periodic payments at interest. This can stretch out capital gains, and provide some flexibility to the buyers in meeting the purchase price.

When selling to family, if the younger generation has to borrow money to pay for the business, the older generation must not act as a secondary guarantor on the loan. Adverse estate or gift tax consequences may arise from this helpful gesture.

If all parties to the sale are related family members, a private annuity may provide some tax advantages. Typically, the parent sells the business to the children, who make an unsecured promise to pay the parents an income stream for life. Each payment is made up of capital gains, interest income, and a non-taxable recovery of the parent’s basis in the business. The income tax issues and unsecured nature of a private annuity are complex enough to call for professional advice before making this part of your plan.

If an outright sale is not possible, or you want to “gift” the business to the kids, you can use a charitable trust as a device to pass the business. There are many ways to structure a charitable trust. Ask your attorney and life insurance advisor which form best suits your situation. In general, the goal is to provide retirement income for the senior generation with minimal adverse tax effect. Gifting the business has many emotional and financial issues that the whole family should discuss. Making assumptions about who will get control and when it will happen can lead you down the road the Hafts are on.

Here is a specific example of a type of charitable trust called a charitable stock bailout. In this situation, family members are the only stockholders, and there are significant retained earnings and liquid assets in the business. This arrangement will allow the primary shareholder to retire and avoid having the business pay dividends. It will transfer the business without gift or estate taxes.

As a first step, the owner establishes a charitable remainder trust (CRT). He or she donates ALL stock to the CRT and gets a tax deduction based upon value of shares transferred, the income stream retained, and current life expectancy. Then the business redeems the stock in the CRT, which reduces retained earnings (All shareholders must have the same offer). The CRT invests the proceeds from the sale of stock, and pays an income stream to the former business owner.

Successors do not have to make payments to the retiring stockholder, the retiring stockholder has removed the asset from the estate, and kept the income stream. There are no gift or estate taxes due. Life insurance on the parents’ lives can be used to replace the retained earnings. Premiums can be funded with the savings in taxes.

In any succession plan, your life insurance professional can answer the question of “How can we guarantee the older generation an income, or protect the younger generation from the financial effects of a premature death?” Planning any family business succession requires teamwork by the family and your professional business advisors. Your accountant, attorney, banker, and life underwriter are crucial to putting the “success” in your succession plan.