Profit & Loss - July 2009

Successful Family Business Planning

by Reed Radosevich

    Business owners face a myriad of decisions every day; decisions that affect the future of their family, as well as their businesses.  Not only do business owners face the challenges of running business today, but also must anticipate future challenges related to business and management succession, estate taxes and liquidity, death and disability.  These challenges take on even greater importance when the business comprises a significant portion of the owner’s family’s wealth.

_{Develop An Exit Strategy Early}

    Whether a business owner plans to retire early or run the business until his/her death, eventually someone else must take control.  Businesses that have a blueprint for the future are not only less likely to fail, but they are also more likely to retain their value, now and in the future.

    Focusing on succession planning and developing an exit strategy can be difficult, especially while working to make a business grow.  But successfully transferring business ownership while minimizing the tax consequences takes time.

_{Determine Whether to Keep the Business in the Family}

    A good place to start succession planning is to determine whether the owner – and the owner’s children – want to keep the business in the family. If transferring ownership to the next generation seems to be the best approach for the business, there is still some groundwork necessary to ensure a successful transition. Laying the foundation for a transition of ownership and management is best done while you are still active in the business, and can provide insight and guidance during the transition period.

_{Before Transferring Ownership, Transfer Management to the Next Generation}

    Allowing the next generation to assume management responsibility gradually allows for the necessary credibility with non-family employees, vendors and customers. This will also give the child time to make mistakes and learn from them and allow the owner time to evaluate the child’s ability to succeed in a senior management role.

_{Selecting the Best Method to Transfer Ownership}

    If a business owner decides to transfer ownership of the business to his/her children, they need to determine the best method for making the transfer.  Transferring interests to family members during the original owner’s lifetime, rather than at death offers several advantages: it allows for the reduction of estate taxes and may also provide cash flow to fund retirement.  A variety of tax-efficient methods are available for transferring ownership, each with different advantages and disadvantages.

_{Using a Grantor Retained Annuity Trust (GRAT)}

    This strategy involves transferring ownership interests to the GRAT in exchange for annual payment of an annuity in cash or in kind for a specified number of years.  When the GRAT terminates, the remaining assets are distributed to the owner’s children, either outright or in trust.  If the owner dies during the GRAT’s term, however, part or all of the assets in the trust will be included in his/her estate.

_{Following a Program of Making Annual Gifts}

    By taking advantage of the annual gift tax exclusion and the lifetime tax exemption, owners can create a planned giving program that could allow them to minimize or even avoid incurring any gift tax liability.  A business owner can transfer ownership gradually without incurring a tax liability.  

_{Creating a Family Limited Partnership (FLP)}

    This technique requires creating an FLP and transferring ownership of the business to it.  By making use of an annual gift tax exclusion and lifetime gift tax exemption, owners can give their children limited partnership interests while minimizing gift tax liability.  As the general partner, the owner would retain control over the business.  However, to avoid incurring estate taxes, they will need to transfer the general partnership interest during the owner’s lifetime.

_{Using an Intentionally Defective Grantor Trust (IDGT)}

    Using this technique, owners sell a minority interest in the business to a trust in exchange for a promissory note.  An IDGT allows owners to continue paying income tax on the assets held in the trust, but their value will be removed from the estate, reducing the eventual estate tax burden.  Continuing to pay the income taxes, rather than using trust assets to pay the taxes, will increase the eventual value that will pass to the heirs.

    Depending on the circumstances, an owner may be able to combine these techniques to achieve his/her desired outcome.  Be aware that some of these techniques have a higher risk of challenge by the IRS than others.  A business owner will want to carefully weigh the advantages and disadvantages of each technique with an estate-planning attorney.

Reed Radosevich
Reed Radosevich is the Nevada President of Northern Trust