Nobody said planning for retirement is easy; that’s especially true for people who run their own businesses. Finding the best way to keep a business operating, while transferring control and/or ownership to someone else, can be dauntingly complex, with the potential for serious tax consequences for all the parties concerned.

The various options fall under the broad category of “succession planning,” which is something every business owner should consider.

Among the ways to transfer a business are outright sales and gifts. Both are generally better choices than simply including the business in your estate, to be sorted out when your will is probated. A number of sophisticated vehicles can be used to transfer a business, either during the owner’s lifetime or at death. They also allow a choice between relinquishing control all at once, or gradually over a number of years.

One very big question, of course, is whether a business will be viable without its current owner at the helm. If not, selling to an outside buyer, or even closing and liquidating its assets, may be the best option. But even when competent management is available to carry on, a systematic approach to succession carries its own set of challenges.

Where it can get very complicated is choosing from the many tools available to balance control, costs, and maximum tax advantage. Those include buy-sell agreements, private annuities, self-canceling installment notes, gifts via trust, and gifts via family limited partnership. Without bogging down into too much detail, I’ll address each of those in turn.

But first, it’s important to emphasize: which approach is best depends, primarily, on the owner’s purpose in transferring a business. For some, it’s simply a matter of maintaining a lifestyle after relinquishing the burdens of running the business. For others, it may be to ensure that estate taxes and other final expenses will be taken care of. On the other side of the coin is the question of who should benefit from the business — which family members, for example — and who is best suited to operate it.

One other very important fact is that, in the great majority of cases, smart succession-planning strategies ensure that a business is transferred without incurring gift taxes. If the transfer is made during the owner’s lifetime, however, those who gain control of the business may have to pay capital gains taxes.

The simplest approach is to give each intended recipient an interest in the business that doesn’t exceed $15,000 each year. That’s the current threshold for the annual federal gift tax exclusion. The drawback, of course, is that at this rate for a large, valuable enterprise, it can take many years to complete the transfer.

For more about gift tax considerations, see my October, 2019 article on year-end planning. 

If you sell the business outright, whether to a family member or anyone else, the deal isn’t subject to transfer taxes as long as the price reflects the full, fair market value. While this isn’t the place to define how that number is determined, let me point out that a sale at less than fair market value may be considered a partial gift for tax purposes.

I mentioned earlier that a sale can take place at any time, even after the owner’s death. A buy-sell agreement is a useful way to control how that works, as well as to spell out details of the payment terms. A buy-sell agreement guarantees that a sale will definitely be made, locking in both the buyer and seller. When that sale happens can be defined as a certain date in the future. Or it can be triggered by a certain event. That might be retirement, disability, divorce, or death.

Keep in mind that if you enter into a buy-sell agreement, it can restrict your ability to reduce the size of your estate by making gifts during your lifetime. So it’s vital to carefully coordinate all the parts of your retirement, estate-planning and succession-planning strategies.

As to who can buy your business: it can be an individual or a group of individuals, such as other co-owners. It can also be the business itself, especially if it’s organized as a corporation or partnership, which has its own legal identity independent of its owners.

A private annuity is a way for a business owner to get a guaranteed income for life. The buyer gets full ownership, but promises to make fixed payments for the seller’s lifetime. As with other kinds of annuities, this can be structured on a “joint and survivor” basis, meaning the seller’s spouse continues to collect after the seller’s death.

Somewhat similar is a self-canceling installment note. This also provides for regular payments to the seller for life, with the obligation satisfied at the seller’s death. The difference from an annuity is that the seller retains a security interest in the sold business, akin to a mortgage lien.

More elaborate, and complex, options include grantor-retained annuity trusts and grantor-retained unitrusts: GRATs and GRUTs. In both cases, assets (such as a business) are transferred to a trust, which makes regular payments to the grantor, usually for a specified period. At the end of that period, the asset goes to the ultimate beneficiary. The difference between a GRAT and a GRUT is that one provides for payments of a fixed dollar amount; the other of a fixed percentage of the trust’s assets.

A family limited partnership is another complex alternative. This has both general and limited partners. The owner, who is the general partner, transfers the business to the partnership and retains control. Then, systematically, the owner/general partner makes gifts of the limited-partner interests to the family members who ultimately will take over.

If all that sounds daunting: it is! Each of these options has major advantages, but also potential drawbacks. All require serious expertise to set up correctly. The Estate and Trust specialists in our company are prepared to assist with succession planning in partnership with your CPA and attorney.

There’s no substitute for experienced personal guidance.

Succession planning is complex, but is a vital consideration for business owners, especially those approaching retirement. To help you manage all the moving parts, and craft a plan that’s best for you, your business, and your family, the experts at Old North State Trust are well qualified to advise you.
 
As Marketing Director, Alyce works to develop, budget, and implement marketing plans, which include advertising, coordination of conferences, special events, and development and maintenance of marketing materials. She also oversees the company’s website, in-house articles, and fostering community initiatives within the organization. Alyce received a BS degree in Interior Design from East Carolina University with a concentration in Business Administration and obtained her teaching certification from UNCW. Old North State Trust professionals have many years of experience and for over a decade have assisted clients in identifying and reaching their financial goals. For more information, visit www.oldnorthstatetrust.com or call 910-399-5470.