Family Business & Your Estate

If you own a family business, you eventually will have to decide when to step down, and then how to do it. Many estate planning tools can be used to transfer your business, but selecting the right one will depend, in part, on whether you plan to retire and let someone else run it for you, sell it, give it away, or keep running the business until you die. Since some options have tax ramifications, you need to discuss them not only with an estate attorney, but with an accountant or financial planner, as well.

If you have children or other family members who wish to continue the business after your death, you need to be sure they are serious. Passing a business to a child or family member who has neither the ability nor the interest in running the business can be disastrous, both for your child and the business.

You want to transfer a business at its full value, but careful planning is essential so that some, or all, of the business assets will not need to be sold to pay income, gift and potential estate taxes, perhaps leaving little for your beneficiaries. Business succession planning should include ways to ensure the continuity of your business, as well as ways to accomplish this with the least tax consequences.

You should not put off succession planning. If you do, your business may have to be sold to someone outside the family to pay taxes, or family squabbles may result. Here are some tips to help ensure a smooth transition from one generation to the next:

Tips for Business Succession Planning

• Start business succession planning early.
  Five years in advance is good. Ten years is better. In fact, many business advisors tell budding entrepreneurs to build an exit strategy into their business plan. The more advance planning you do on succession planning, the smoother the transition is likely to be.
• Involve your family in planning discussions.
  Your family needs to be part of the planning process. Making and then announcing your own succession plan without involving the family is a sure way to guarantee problems. You need to open the dialogue, paying close attention to personal feelings, ambitions and the goals of everyone concerned.
• Look at your family realistically and plan accordingly.
  You may want your first-born daughter to run the business, but be sure she has both the skills and the interest to take on the business. Another family member may be more capable, and if no family members are interested in continuing the business, you might want to sell it. You need to examine the strengths of all possible successors objectively, and then think about what would be best for the business.
• Get over the idea that everyone has to have an equal share.
  Though giving everyone in your family an equal share may sound like a good idea, that may not be in the best interests of your business. Since management and ownership are separate issues, your chosen successor to run the business may deserve a larger share of business ownership than family members not active in the business. In that case, maybe you should transfer both management and ownership to your chosen successor and make other financial arrangements to benefit your other children.
• Train your successors and work with them.
  You cannot expect your successor to run your business successfully without training. Your family business succession plan will have a much better chance of success if you work with your successor(s) for several years before you leave. For solo entrepreneurs, sharing decision making and teaching business skills can be difficult, but definitely the worth the effort to assure continuing success for the business.
• Get professional help with your business succession planning.
  Companies that specialize in family business succession planning can help you resolve both family and succession plan issues. Business and estate planning lawyers, accountants, and financial advisors also can help you develop a successful plan.

The Best Way to Transfer a Business within the Family

If you just gift it during your lifetime, you face potential tax problems. You are allowed to give up to a total of $14,000 in cash and/or other assets, per person per year without having to report the gift for federal tax purposes. If you’re married and your spouse joins in the gift, the amount increases from $14,000 to $28,000. If you and a spouse make a gift to a child and his spouse, the total you can gift in the year (before having to report it) would be $56,000. To the extent the gift exceeds $14,000 (or $28,000 if married), you must file a gift tax return, but no tax is due unless your gift is in excess of your lifetime gift tax exemption (in 2016, the lifetime exemption is $5.45 million, up from $5.43 million in 2015).  But if your business is worth more than you’ve given to them over the years, that is probably not a good solution because they may still wind up having to pay substantial taxes.

Another option would be to form a partnership with your child. This, too, creates some problems because partnerships automatically end with the death of a partner. If you pass away unexpectedly, your share of the business would be involved in probate court and could face hefty estate taxes.

If you decide to give the business to your child in your will, you will have the same problem with taxes and probate.

Another option would be to sell your business outright, either to your child or another family member. The cash or assets you receive can be used to maintain your lifestyle or pay your estate taxes. You can sell now, at your retirement, at your death, or any other time. A sale before your death will be subject to a capital gains tax, to the extent the sales price exceeds the tax basis in the business. But as long as the sale is for the full fair market value, proceeds are not subject to gift tax or estate tax.

You may transfer your business interest with a buy-sell agreement, which is a legal contract that prearranges the sale of your business interest between you and a willing buyer. Such an agreement lets you keep control of your interest until the event that the agreement specifies, such as your retirement, disability, or death. When the triggering event occurs, the buyer is obligated to buy your interest from you or your estate at full market value. Price and sale terms are prearranged, so you, or your estate, and the buyer are bound by the agreement. You cannot sell or give your business to anyone other than the buyer named in the agreement without the buyer’s consent. This kind of agreement could restrict your ability to reduce the size of your estate through lifetime gifts, unless you carefully coordinate your estate planning goals with the terms of your buy-sell agreement.

Many people form a living trust to transfer a family business to a family member. A living trust is a useful estate-planning device that bypasses probate. It is a separate legal entity, like a corporation. While you are living, you transfer the business into the trust, of which you are the trustee. Then the trust owns the business and you benefit from it. If you make your child the beneficiary of the trust, your child will own the business after you are gone.

One of the most common and best ways is to transfer shares of the business to your children each year, which has the effect of reducing your tax basis and the value of your holdings at the date of your death. For example, if you had transferred 40% of your business by the time of your death, your estate would be eligible for various discounts, (i.e., marketability) and the fact that it has a minority stake.

If you want to pass your family business to the next generation, you should not delay succession planning. A good succession plan can ensure that you have the funds you need for retirement and that your business will continue to thrive in the hands of the next generation. Be sure to consult an estate-planning attorney to assist you in tailoring your estate plan with your business succession strategy.

Case Studies: Family Business and Your Estate

Case Study 1: Gift During Lifetime

John is the owner of a successful family business and wants to pass it on to his son, Michael. He considers gifting the business during his lifetime. However, John is concerned about potential tax implications, as gifting the full value of the business may lead to substantial taxes for Michael. He seeks advice from an estate attorney and accountant to explore more tax-efficient alternatives.

Case Study 2: Partnership With a Child

Sarah has built a thriving family business and wishes to involve her daughter, Emily, in its management. Sarah contemplates forming a partnership with Emily to transfer ownership gradually. However, she is aware that partnerships automatically dissolve upon the death of a partner, which could lead to probate issues and estate taxes.

Case Study 3: Outright Sale to a Family Member

Robert has decided to retire and transfer his family business to his son, Daniel. He considers selling the business outright to Daniel or another family member. By selling at fair market value, Robert can maintain his lifestyle or pay his estate taxes using the cash or assets received. Robert understands the importance of consulting with professionals to navigate the capital gains tax implications and ensure a proper transfer of ownership.