Succession Planning : Transfer Tools & Options

When it comes time to passing your family-owned business on to the next generation, there is an incredible array of questions you’ll need to answer and options to consider. It’s not as simple as handing them the keys to the door.

Although there are many additional estate planning tools and options, there are four main transfer options I see most often that you can build your succession plan around. They include:

  • Direct Gift
  • Sale via Intentional Defective Grantor Trust (IDGT)
  • Grantor Retained Annuity Trust (GRAT)
  • Bequest

Direct Gift:

A direct gift is the simplest way to transfer ownership of your business to the next generation. This involves outright giving shares or assets of the business to your heirs. While straightforward, it’s essential to consider potential gift taxes and the impact on your estate. Additionally, this method works best when the business is relatively small, and the recipients are prepared to take on immediate ownership responsibilities.

Pros:

No income Tax for either party

Easy to implement

Cons:

Possible gift tax due

A formal business Valuation will be required with IRS Filing

No stepped-up basis in the asset.

Typical Uses:

Common under 2020 estate and gift laws, because of the very high lifetime exemption for tax free gifts ($11.58M)

Sale via Intentional Defective Grantor Trust (IDGT)

An IDGT is a sophisticated estate planning tool that allows you to sell your business to a trust while retaining certain powers over the trust. The sale is structured so that the transaction is not recognized for income tax purposes, but it removes the asset from your estate for estate tax purposes. This method allows you to freeze the value of your business for estate tax purposes while allowing any future appreciation to pass to your heirs tax-free. It’s a complex strategy that requires careful planning and legal expertise but can be highly effective for larger businesses with significant growth potential.

Pros:

No gift tax may be due if it is sold at appraised value, this is an actual sale of the stock that is repaid over time.

No income taxes due on the sale.

Seller can also elect to continue to be taxed on the income so that additional cash can be removed from the estate every year without gift taxes due.

Income from the business goes to the purchaser, which allows them to fund the repayment of the purchase.

 Recurring income stream to seller.

Cons:

The seller is taxed as gift on any amount the sales price is less than fair market value.

A formal business valuation will be required with IRS filing.

If note is not paid by the time of seller’s death, the remaining amount would still be taxable in the estate

No stepped-up basis in the asset sold.

Typical Uses:

 Seller still wants recurring income stream but wants to freeze the value of the business for tax purposes, seller could choose to sell only non-voting shares and still maintain control.

Grantor Retained Annuity Trust (GRAT)

A GRAT involves transferring your business into a trust while retaining the right to receive annuity payments for a specified term. At the end of the term, the remaining business interest passes to your heirs. This strategy can be advantageous in a low-interest-rate environment, as the success of the GRAT depends on the business’s appreciation exceeding the IRS’s assumed rate of return. One key benefit is that if the business grows significantly, the excess growth passes to your heirs with minimal tax implications. However, if you pass away during the annuity term, the trust’s assets may revert to your estate.

Pros:

Can be structured with minimal gift taxes dues.

Recurring income stream to seller during the duration of the trust.

If the seller survives the term of the payments, the amount can be excluded from estate.

Cons:

If the seller dies before the income stream is complete, the income is taxable in the estate.

Typical Uses:

If the company has very highly appreciated assets, or has a low basis

Bequest

A bequest is the transfer of your business through your will. This method allows you to retain full control of your business during your lifetime and specify the terms of the transfer upon your death. While straightforward, this approach may trigger estate taxes, depending on the value of your estate and applicable exemptions. Properly structuring a bequest can help ensure a smooth transition and minimize potential tax burdens for your heirs.

Pros:

Seller keeps complete control until death.

Stepped- up basis for recipient.

No income taxes due.

Cons:

Estate will pay tax on value upon death using the future (unknown) estate rates.

In order to pay the taxes at death, life insurance may be needed and can be expensive for older, less liquid or at-risk sellers.

Typical Uses:

The seller has a need for control and recurring cash flow but wants to ensure the business stays in the family.

Each of these options has its advantages and complexities. It’s crucial to work with experienced financial advisors and estate planning attorneys to tailor a succession plan that aligns with your business goals and family dynamics. By thoughtfully planning your business transfer, you can help secure your legacy and ensure the continued success of your family-owned enterprise for generations to come.

Start planning early

There are many decisions that need to be thought through when deciding on a succession plan to gift or a sell a business to a family member. The more time you give yourself to plan, the better.

Strong succession planning is key to the future of your business. Contact us today to get started.

This material has been prepared for informational purposes only, and is not intended to provide, and should not be relied on for, accounting, legal or tax advice.  The services of an appropriate professional should be sought regarding your individual situation.

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