Estate Planning For Business Owners
Your personal estate plan makes sure there's an orderly disposition of your assets once you're gone. But what about your business? It's an integral part of your personal estate, and it needs an estate plan of its own that addresses two crucial issues--who will take over your role, and how best to transfer your interest in the company to family members or an outside buyer.
Selling out to a competitor or other outsider may be the most lucrative route. But it's often easier and less traumatic to pass control to insiders such as business partners or your children. Several strategies can minimize business disruptions and gift and estate taxes. Whatever your approach, however, the first step is to get an independent appraisal of your business's value. Knowing what the business is worth is essential to almost every transfer technique.
Selling to your business partner. Here, the main issue is how to transfer your share of the business without soaking up your company's or your partner's cash. The most common technique involves a buy-sell agreement--often called a shareholders' agreement--funded with life insurance. Typically, this requires the estate of a deceased partner to sell his or her interest to one or more surviving partners. The insurance to finance the transaction may be owned either by the company or the partner.
Discounting your gift. Whenever you transfer a share of your business to family members--during your lifetime or at your death--taxes stand to reduce the value and may cause liquidity problems. One way to minimize tax liability is to give minority interests that the IRS allows you to discount for tax purposes. Suppose you give your daughter a one-third interest in your business. Because she can't easily sell that stake, you can discount its value by about 35%. So if your company has been appraised at $3 million, only $650,000 of the $1 million gift would count against your $1 million lifetime gift-tax exemption. Moreover, transferring that interest now means future appreciation in the business will occur outside your estate.
Giving equity without control. Your estate plan may need to accommodate both children who work in the company and those who don't. One solution is a recapitalization plan that issues voting and non-voting classes of stock. Family members not in the business receive non-voting shares that give them equity but not control.
Using a GRAT to leverage your gift. Various trusts provide tax benefits and can also help protect the company from claims that might arise out of a family divorce or bankruptcy. With a grantor retained annuity trust (GRAT), for example, you put shares of the business into trust in return for an annuity paid out at an interest rate set by the IRS. Gift tax is assessed at the outset, based on the presumed value of the shares at the end of the trust's term, when the shares are distributed to the trust's beneficiaries. Your heirs come out ahead if the shares in the trust increase in value at a rate higher than the annuity rate. That's all the more likely given that the shares' value is discounted on the way into the trust. But if you die before the trust term ends, the business interest reverts to your estate, where it may generate estate taxes. So you need to choose a term you can realistically reach.
Taking advantage of intentional defects. Another trust strategy involves selling a business interest to an intentionally defective grantor trust. Here, the grantor and the trust are largely treated as the same entity, thus avoiding capital gains taxes on the sale and income tax on installment payments you receive. Yet the trust proceeds pass to your heirs without gift or estate tax consequences.
Because each of these business estate strategies has drawbacks as well as benefits, you may want to use a combination of approaches. "It's not a good idea to put all of your eggs in one basket," says Stephen J. Silverberg, a New York estate planning attorney. Nor can you afford to neglect estate planning basics. That means making sure to consult with a qualified estate planning attorney to ensure your will, a health-care proxy, and durable power of attorney are in order, and that your wishes for the future of your business are spelled out and included in your personal estate documents.
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