BUSINESS SUCCESSION PLANNING: Reduce Taxes & Prepare for the Future

By Jeremy Graber: Partner-in-Charge Foulston Siefkin LLP Topeka

For the business owner, there is no right time to start succession planning. But there is certainly a wrong time, and that’s when it is too late, often after a significant life event. Regular business matters often take precedence over longer-term planning for an issue with an uncertain timeframe.

But as gift and estate tax limits roll back in 2026, and possibly earlier if Washington acts, now may be the time to start a business succession plan and position yourself for tax benefits.

Succession planning is developing a plan to transfer ownership and/or management of your business.
Decisions about the economic benefits, control and timeframe do not have to be implemented all at once. You can transfer some or even most of the economic benefits to your children now, while retaining full control until later. Similarly, perhaps you can transfer day- to-day management to another person but maintain an economic interest in your company.

TAXES

ESTATES WORTH MORE THAN $11,700,000

Currently, the estate tax exemption is $11,700,000. If your estate’s total value at your death plus prior taxable gifts is less than that amount, you owe no estate tax. Your estate will pay 40% of any amount over $11.7 million. The exemption doubled in 2018, but sunsets at the end of 2025, dropping to roughly $5.5 million. Of course, Congress could accelerate the sunset or change it altogether. Most practitioners do not believe this “bonus exemption” will continue past 2025, so if your taxable estate exceeds $5.5 million at that time, 40% goes to Uncle Sam. Those who have a taxable estate should take advantage of the bonus exemption by making gifts and taking steps now to reduce future estate tax exposure.

PLAN NOW FOR ESTATES OF ALL SIZES

Even if you think your estate won’t be taxable, here are two reasons to act now: 1) everyone should have a plan, regardless of taxes; 2) the value of your company will likely grow. By gifting some of the economic interest now, the future growth avoids estate tax.

For example, what if your $4 million company doubled in value over the next seven years? Or tripled in 10? Now you have a taxable estate with significant taxes due (assuming the sunset goes into effect). What if, instead, you gifted $2 million of the economic value (non-voting interest) to your children or an irrevocable trust now, and then the company’s value doubled? Your estate would be worth $4 million, and the $2 million previously gifted would be worth $4 million as well, but because it is outside of your estate, no estate tax is due. As shown in the chart below, even small transfers now can pay off in large dividends down the road.

PLANNING IDEAS

Where to start? Consider who receives company interests (voting or non-voting) and when.

GIFTING

Let’s say Maria owns 100% of a $4 million company. Of her three children, only Brylen works in the business. Maria doesn’t plan to retire in the next 10 years, but she wants to move some assets out of her estate, treat the kids equally and ultimately leave control to Brylen. First, Maria may convert her 100 voting shares to 98 non-voting shares and 2 voting shares. She then creates an irrevocable trust for her three children with her spouse or trusted business partner as the trustee and immediately gifts 51 non-voting shares to the trust. This leaves her with 47 non-voting shares and 2 voting shares (49% of the economic value but 100% of the vote). On her death, this trust would distribute these shares to the three children equally.

While maintaining full control, she has shifted the majority of the economic value outof her estate. In the upcoming 10 years, she may consider gifting additional, smaller shares to the trust. Her 2 voting shares retain company control now and create a vehicle to hand management to Brylen later. In five years, perhaps she gives one voting share to Brylen, and the other when she retires, then equalizes the economic interest among her other children with non-voting shares.

Another key piece of Maria’s plan would be a robust buy-sell (or shareholder) agreement. It would include provisions keeping the non- involved children from being shut out of economic interests and allowing them to sell out if they wanted to liquidate their interest (presumably after her retirement or death). But this right might be accompanied with a payment term over 10 years to avoid forcing Brylen to distribute immediate cash that may cripple the business. The buy-sell agreement would also keep anyone from selling outside the family without first offering it to the others and other rights that ensure all shares stay together if the company is sold to a third party.

SELLING

Selling part of the company is a succession planning option too. Some parents want the next generation to have “skin in the game” just as they did when they were building the business. With interest rates extremely low, now is a great time for intra-family loans. Selling part of the business over an extended period with low interest can be a way to transfer part of the company’s interest and lock in the value but still maintain control and have the transfer restrictions through the buy-sell agreement discussed earlier. Some owners also use loans for their future cash flow even though the next generation is now the owner and management.

START NOW

Succession planning options are nearly boundless. But keep in mind the old saying: Don’t let the perfect be the enemy of the good. Starting a succession plan – even a simple or imperfect one – is better than no plan at all.