Irv Blackman Irv Blackman
Independent Financialservices Professsional

Don't Fear Succession Planning

March 1, 2017

Some things are downright scary—estate taxes, for example. Can you guess what aspect of estate-tax planning causes the most anguish? Hands down, it’s business succession.

All successful business owners share a common future (no exceptions): Someday they must pass the management baton. Most fear that day.

President Franklin Roosevelt said, “Fear paralyzes those who succumb to it.”

Here are six questions that lead the unwelcome-fear-factor parade when it comes to business-succession planning:

1) How high will my income tax/capital gains taxes be if I sell to the kids or employees now?

2) If I wait to sell, how much will the increasing value of the business raise my estate-tax liability?

3) Will I get paid, and be able to maintain my (and my spouse’s) lifestyle?

4) Will the bank let me off the hook for the business loans I guaranteed?

5) How can I treat my nonbusiness child fairly?

6) And, the number one fear—giving up control. Very few business owners relish giving up control of the business. About 30 percent of business owners who ask me to prepare their estate plans own 51 percent of their business, while the kids own the other 49 percent, because they fear losing control.

How do I develop solid business-succession plans (accepted by the IRS) that will calm business-owner’s fears? I turn every fear into a goal, and then explain how to apply the correct strategy (one which I have used over and over again) to accomplish every goal.

For example, consider this recent case, describing a reader/business owner (Joe) of this column, married to Mary and whose son Sam (age 31) runs—and will someday own—the family business (Success Co., an S corporation).

Let’s list Joe’s fears, which we have turned into goals.

1) Keep control for life. Joe owns 100 percent of the stock of Success Co. We recapitalized Success Co. to create voting and nonvoting stock; Joe owns 100 shares of voting stock and 10,000 shares of nonvoting stock—a tax-free transaction. The strategy allows Joe to keep the voting stock, and control, until he dies. The nonvoting stock transfers to Sam.

Note: If Joe owned only 51 percent of Success Co., he would own only 51 shares of voting stock and 5100 shares of nonvoting stock.

2) Transfer Success Co. to Sam now, freezing the value without getting beat up with income/capital-gains taxes. Then, sell the nonvoting stock to an intentionally defective trust (IDT). The tax beauty of an IDT: Joe legally avoids capital-gains tax on the sale ($8 million for example, paid with a note) and income tax due on the interest he is paid on the note.

Typically, the note is paid in full over 5 to 8 years using the cash flow of Success Co. Then, the IDT trustee distributes the nonvoting stock to the trust beneficiary (Sam), who never pays even a dollar to own the nonvoting stock.

Note: For every $1 million of a company's price, the tax savings will be about $190,000.

3) Make sure that Joe and Mary can maintain their lifestyle for as long as they live. Joe continues to work every day, at full salary but for fewer hours. The intent is for Joe to cut his salary and days worked once his IDT note is paid in full.

4) Remove Joe’s bank guarantee for Success Co.’s loans. During a meeting at the bank, the term-loan provisions were rewritten, removing Joe's guaranty once his IDT loan was paid.

5) Treat the nonbusiness child (Susan) fairly. Remember, Success Co. is an S corporation—every year the IDT will receive a dividend from Success Co. Here’s the strategy: We had the IDT buy second-to-die life insurance on Joe and Mary, and named Susan the beneficiary of the IDT for the amount of the insurance, enough to treat her fairly. The annual dividend distributions first are used to pay the insurance premiums and then to pay the IDT note. MF

Industry-Related Terms: Case, Transfer
View Glossary of Metalforming Terms

Technologies: Management


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