business succession planning

BUSINESS SUCCESSION PLANNING

November 2011

IRS Circular 230 Disclosure: To ensure compliance with the requirements imposed by the IRS, we inform you that any tax advice contained in this communication, including any attachment to this

communication, is not intended or written to be used, and cannot be used, by any taxpayer for the purpose of (1) avoiding penalties under the Internal Revenue Code or (2) promoting, marketing or

recommending to any other person any transaction or matter addressed herein.

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Closely Held Businesses

• Comprise more than 80% of U.S. enterprises

• Employ more than 50% of the nation’s workforce

• Account for the bulk of America’s gross domestic product

• Owners represent an aging population

Tuesday, April 18, 2023

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Passing the Baton

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Buyers Assessment of Value Tax Issues

Oracles Nucleus

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A Strategic Plan• Time frame

• Evolving analytical process

• Family dynamics

• Realistic goals and forward focused

• Team effort


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Threshold Questions • Keep or sell? Spell out

alternatives

• Recognize critical factors

• Identify operations risk and business indicators

• Know your client and their business


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Key Business Indicators• Strategically-Based vs. Relationship-Based

• Is institutionalization possible?

• Margin tolerance

• Asset base

• Low-Tech vs. High-Tech

• Barriers to entry

• Capital structure


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Planning Elements• Timing

• Valuation

• Entity Form

• Insurance

• Family Planning


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Forms of Closely Held Businesses• Sole Proprietorship

• Corporation

• Partnership

• Limited Liability Company


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Valuation Factors• The Appraiser

• Fair Market Value

• Valuation Methods

• Discounts and Premiums


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Smith Family Distributing, Inc.• The Smith family owns a business that is going to be transitioned to the next

generation. The selloff option is presumably off the table, at least during the preliminary planning stages and initial family discussions.


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Smith, Inc.

The Smith family owns a business that they want to transition to the next generation.


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Smith, Inc.

MaggiePresident

Raymond(Husband)

90% Stock Ownership as CP

John(son and driving force)

10% Ownership

Karen (daughter)

Horace(son)

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Tax Issues

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Asset vs. Stock Sale


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Traditional Asset Sale


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Smith, Inc.

C Corp.

* Status prior to asset sale

Shareholders100%

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Smith, Inc.

C Corp.

* Buyer borrows money or issues equity

Shareholders

100%

Buyer

Federal/state government

$25 million purchase price

Sale of assets

• Buyer purchases Smith, Inc. assets for $25 million

• Corporate tax of 40% paid by Smith, Inc.

$10 million taxes paid

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Smith, Inc.

C Corp.

Shareholders $11.4 million

remaining

$15 million distribution


• Smith, Inc. distributes after-tax proceeds from sale to shareholders

• Shareholders pay 24% capital gains tax

• Shareholders net $11.4 million

$3.6 million taxes paid

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Traditional Stock Sale


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Smith, Inc.

C Corp.

* Status prior to stock sale

Shareholders 100%

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Traditional Stock Sale


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Smith, Inc.

C Corp.

Shareholders$14.25 million

remaining

100%

Buyer


$

Sale of stock

• Buyer borrows money or issues equity

• Buyer purchases stock of Smith, Inc. for $18.75 million

• Shareholders pay 24% capital gains tax

• Shareholders net $14.25 million

$4.5 million taxes paid

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Lifetime Gift


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Smith, Inc.

C Corp. * Maggie and Raymond gift all of their shares of stock to John during their lifetime

Maggie & Raymond

90%

100%

John 10%

All Maggie and Raymond’s shares of Smith, Inc. stock

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Lifetime Gift


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Smith, Inc.C Corp.

$25 million

John 100% Shareholder

Federal government

• John is now 100% shareholder of Smith, Inc. (He does not pay income tax on the gift received.)

• Maggie and Raymond must file federal gift tax return in year of gift.

• Maggie and Raymond will pay 35% federal gift tax on amount of gift over $10 million.

$5.25 million gift tax

Taxable Gift $15 million

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Transfer by Inheritance


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Smith, Inc.

C Corp. • Maggie and Raymond leave all of their shares of stock to John in their wills (or via revocable trust)

• Once both Maggie and Raymond pass away, John will be sole owner of Smith, Inc.

Maggie & Raymond

90%

John 10%

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Transfer by Inheritance


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Smith, Inc.

C Corp.

John 100% Shareholder

Federal government

• John is now 100% shareholder of Smith, Inc. (He does not pay income tax on the inheritance.)

• On death of second spouse to pass away, estate will pay 35% federal estate tax on everything over $10 million.

$14 million gift and estate taxes

Maggie and Raymond’s

taxable estate $40 million

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What techniques should apply to every business owner?

• Transfer mechanism—• Probate• Trust• Joint Tenancy

• Consider: Who will be Trustee:• Family Member• 3rd Party

• Buy-out Non-participant Spouse• Buy/Sell Agreement

• Financing Taxes/Buyout• Savings• Insurance• Section 6166


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Probate: The Good The Bad & The UglyThe Good:• Court supervised• Creditors Cut Off• Get to work with lawyers!

The Bad:• Slow and Time Consuming• Frustrating• Costly• Public

The Ugly:• Have to work with LAWYERS!

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Probate (Will) vs. Trust

If the Smith Family Trust holds the stock, generally no probate.


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Smith, Inc.

MaggiePresident

Raymond(Husband)



10% Ownership

Karen (daughter)

Horace(son)

Smith Family Trust

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Who should be the Trustee?

Smith Family Trust becomes the shareholder


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Smith, Inc.

MaggiePresident

Raymond(Husband)



10% Ownership

Karen (daughter)

Horace(son)

Smith Family Trust• Stock

• Real Estate• Cash & Investments

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Who’s Driving the Vehicle?

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Corporate Governance:

Are the Smith Family Trust and the Smith, Inc. bylaws in sync (or do they contemplate

differing solutions)?


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Smith, Inc.

MaggiePresident

Raymond(Husband)



10% Ownership

Karen (daughter)

Horace(son)



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How to pay Estate Taxes?

Are the Smith Family Trust and the Smith, Inc. bylaws in sync (or do they contemplate

differing solutions)?


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Smith, Inc.

MaggiePresident

Raymond(Husband)



10% Ownership

Karen (daughter)

Horace(son)



IRS$$?

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Pre-sale or TransferStrategies

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Pre-sale or TransferTechniques—Four Categories:

• Valuation Strategies• Fractionalization• Interest Rate/Time Value

Arbitrage• Control Wrappers

• Generation Skipping

• Charitable Techniques

• Insurance

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Summary

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Team

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Attorney

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Accountant

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Valuation Specialist

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Investment Banker/Business Broker

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Financial Advisor

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Passing the Baton

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Buyers Assessment of Value Tax Issues

Oracles Nucleus

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Questions?

business succession planning

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