Plan for family Succession

Written by

Tom Cooney and Crystal Faulkner

I own a small business, and some of my children work for me. I don't want to give up control of my business, but I also don't want to miss out on any tax-savings opportunities. Do you have any practical tips for results-driven succession planning?

The Tax Relief Act of 2010 provides you an opportunity to shift a portion or all of the ownership of your business to your children by taking advantage of the $5 million gift tax exemption ($10 million if combined with your spouse) that was included in the law passed by Congress late last year. The additional gift tax exemption combined with the fact that many businesses are worth less than they were before the recession makes this a great time to be thinking about succession planning since a larger portion of the ownership in your company may be transferred at lower values.

The fear of losing control of your company is very valid and a concern we hear frequently from entrepreneurs. You've undoubtedly worked hard to build your business and you want to make sure the value isn't compromised. The good news is that you can transfer a portion of your business without relinquishing control of the entire company. There are many ways to maintain control depending on the legal structure of your business. For example, you may be able to restrict voting and transfer rights on the ownership that you transfer. In addition, you may be able to utilize trusts to own the shares or units transferred.

Before you decide on the method of transfer, your biggest challenge may be deciding if the business should remain in your family or sold to an outsider or to management. Assessing whether your children have the appropriate skills and abilities to run the business is difficult and often emotional but this issue should be addressed early and periodically reviewed. If your children are not yet in significant management roles you may also want to include key members of management in your succession plan. You should consider motivating your key employees to remain with the company through the management transition. You may want to explore phantom stock arrangements or deferred compensation agreements as an incentive for your management team to stay on board through the transition and beyond. In some cases, an ESOP, which allows employee ownership, may be appropriate. If you decide that your business should remain in the family, you'll need to address several objectives to make the transfer successful.

A primary goal that you should consider is how to transfer your ownership to the active family members of your business using the least amount of your gift exclusion and minimizing your tax cost. If you wait until your death to transfer, your estate may not have enough liquidity to meet tax requirements which means the estate may need to sell the company. Of course, you want to retain enough business or non-business assets so that you will be able to maintain your lifestyle after the transfer.

For a smooth transfer, you should focus on creating wealth for yourself independent of your business. You can use creative retirement options which in turn will make the transition much easier. You may be able to utilize deferred compensation plans, consulting agreements, non-compete agreements, employment contracts or other means to help assure your stream of income. If you own real estate in conjunction with the operation of your business you may be able to utilize the real estate to maintain your income stream.

When transferring family wealth through a business it's preferable to transfer ownership to the children who work in the family business. Many parents want to be sure that all of their children are treated equally and make the mistake of allowing the children who do not participate in the family business to also have ownership. Generally, this is not a good idea and often causes family feuds between siblings. Non-business assets (such as life insurance and real estate leased to the operating company) should be used for any of your children who aren't active in your business. This allows you to maintain as much equality as you want without encumbering the management of the business.

Business succession planning is one of the most crucial parts of your estate plan and critical for the long-term success of your organization. If you don't plan appropriately you will needlessly end up paying more in estate and gift tax to the IRS, which reduces your family's overall wealth. It's not an easy process, but proper succession planning is one thing you should definitely do to help carry on your legacy. You should consult with your professional advisors that are familiar with your circumstances for their ideas.

Consult us: 716-565-1300 or anecamara@mintcofinancial.com

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