Estate planning is one thing; estate planning for a business owner is another. For the business owned, the business typically represents a large proportion of his/her potential estate. Not only does that create concerns about liquidity to pay estate tax, the planning has to take into account all the emotional aspects of business succession. Planning for business owners takes longer and requires perseverance. The owner may run hot and cold, struggling with what to do with the business.
The “Post-Business” client.
The best estate planning for business owners can be summed up as “do not die before you get the management (and hopefully the ownership) of the business transferred to where it should go”. Frequently this approach means that there is a short term estate plan that involves what happens if you go down in a plane now, and another plan put in place after you transfer the business. The two plans will look very different.
The short term plan might involve life insurance in order to avoid having a fire-sale of the business in order to pay tax. It should also assume a management nightmare resulting from the loss of the key executive. In this a case, the choice of Trustees might involve people who could step in and run the business or manage a more orderly liquidation.
The long-term plan will be relatively simple because it will assume that the succession of the management of the business has been accomplished, so that short term liquidity is not the big concern.
Separating value from control.
Many clients assume that transferring equity in a business must involve both the management of the business and the economic value of it. But sometimes the value should be transferred to different people or at different times from the controlling interests. One way this can be accomplished is by recapitalizing to create voting and non-voting stock. Or in the LLC context, creating different classes of membership interests. The business owner might have some children interested in the business while other children are not. Alternatively, there might be key non-family employees in mind for management roles, but children to whom he wants to give economic interests.
Selling versus gifting.
If the client is wealthy, transfers will be made in the form of gifts as opposed to outright sales. On the other hand, if the owner still needs to provide for his/her financial security (and that of his or her spouse), the transfers might be more sale than gift. The owner needs to first look out for number one, and that means establishing a comfort number of relatively liquid and safe assets to live on. If that has not already been accomplished, transfers through the use of a sale (family or otherwise) might be considered. It should not be overlooked that cash flow from a transferred interest in the business could well underwrite the sales price. And, the stream of payments resulting from a sale of business interests could serve as a retirement income for the former owner.
In deciding which assets to transfer and when, the concept of leverage should be considered. To me, that leverage means two things. First, can the property be valued at modest amounts through the use of discounts? Second, will the property appreciate in the future after the transfer, thereby removing the increased value from the estate of the business owner?
If the business owner’s potential estate is large enough that estate tax is a concern, leveraging transfers may be important. Life-time gifts involve the use of the business owner’s unified credit, which is a fixed amount. So the amount of wealth that can be transferred should be maximized using a specific amount of that credit. Gifting non-controlling interests in closely held entities can create such valuation discounts.
Basis adjustments upon death.
If the idea of making life-time gifts is on the table, another consideration might be whether there is a built-in tax gain in the property to be transferred. If the business owner dies owning property (and or not, accordingly that property is included in his/her estate), the person receiving the property will take a tax basis equal to its fair market value. If the same property had been gifted prior to death, the tax basis would carry over to the done and the family would have missed an opportunity to avoid the income tax on the appreciation. So clients should think twice about making life-time gifts of property with substantial tax gains built-in to them unless the gift can be properly leveraged.
Article Contributed by Paul Steckel, CPA
About MKS&H: McLean, Koehler, Sparks & Hammond (MKS&H) is a professional service firm with offices in Hunt Valley and Frederick. MKS&H helps owners and organizational leaders become more successful by putting complex financial data into truly meaningful context. But deeper than dollars and data, our focus is on developing an understanding of you, your culture and your business goals. This approach enables our clients to achieve their greatest potential.