August 14, 2024
If you own a family business, it’s probably one of your most significant personal assets. It’s important to take the proper estate planning steps to ensure that the business lives on after you’re gone — if you don’t, you may be placing your family at risk.
Ownership vs. Management Succession
One reason transferring a family business is such a challenge is the distinction between ownership and management succession. When a business is sold to a third party, ownership and management succession typically happen simultaneously. But in the family business context, there may be reasons to separate the two.
From an estate planning perspective, transferring assets to the younger generation as early as possible allows you to remove future appreciation from your estate, minimizing estate taxes. On the other hand, you may not be ready to hand over the reins of your business or you may feel that your children aren’t yet ready to take over.
There are several strategies owners can use to transfer ownership without immediately giving up control, including transferring ownership to the next generation in the form of nonvoting stock, or establishing an employee stock ownership plan. Alternatively, you might place business interests in a trust, family limited partnership (FLP) or other vehicle that allows the owner to transfer substantial ownership interests to the younger generation while retaining management control.
Another reason to separate ownership and management succession is to deal with family members who aren’t involved in the business. Providing heirs outside the business with nonvoting stock or other equity interests that don’t confer control can be an effective way to share the wealth while allowing those who work in the business to take over management.
Conflicting Financial Needs
You also might need to work around the conflicting needs of older and younger family members. Fortunately, several strategies are available to generate cash flow for the owner while minimizing the burden on the next generation. Examples include:
Installment sales. Using installment payment to sell the business to children or other family members provides liquidity for the owners. This strategy simultaneously eases the burden on the younger generation and improves the chances that the purchase can be funded by cash flows from the business. Plus, as long as the price and terms are comparable to arm’s-length transactions between unrelated parties, the sale shouldn’t trigger gift or estate taxes.
Grantor retained annuity trusts (GRATs). You could transfer business interests to a GRAT. This strategy provides owners with a variety of gift and estate tax benefits (provided they survive the trust term) while enjoying a fixed income stream for a period of years. At the end of the term, the business is transferred to the owners’ children or other beneficiaries. GRATs are typically designed to be gift-tax-free.
Installment sales to intentionally defective grantor trusts (IDGTs). This is a somewhat complex transaction, but essentially a properly structured IDGT allows an owner to sell the business on a tax-advantaged basis, while enjoying an income stream and retaining control during the trust term. Once the installment payments are complete, the business passes to the owner’s beneficiaries free of gift taxes.
Because each family business is different, it’s important to work with your estate planning advisor to identify appropriate strategies in line with your objectives and resources.
Be Proactive
Regardless of the strategy you choose, the earlier you start planning the better. Transitioning the business gradually over several years gives you time to educate family members about your succession planning strategy. It also allows you to relinquish control over time, and to implement tax-efficient business structures and transfer strategies. Reach out to your tax advisor to understand the tax implications, or contact the GRF Tax Team for more information.
© 2024
