Portrait of Richard L. Craig

When it comes time to pass your family-owned business on to the next generation, there is an incredible array of questions you’ll need to answer and options to consider. It’s not as simple as handing them the keys to the door.

Although there are many additional estate planning tools and options, there are four main transfer options I see most often that you can build your succession plan around. They include:

  • Direct Gift
  • Sale via Intentional Defective Grantor Trust (IDGT)
  • Grantor Retained Annuity Trust (GRAT)
  • Bequest

The chart below explains typical uses of these options, as well as their pros and cons.

 Succession Chart

One decision made can easily lead to five more decisions to make. Many factors can influence which direction you want to go. So, here are five major questions to ask yourself—and your family—before formulating a business succession plan.

Do you want to pay taxes now or later?

There are two types of taxes: income tax and gift or estate tax. Everyone who makes money pays income tax annually. Gift or estate tax is what you pay when you gift a certain amount over your lifetime or pass away with a specific amount left over. The current amount is the highest it’s ever been; you’re allowed to gift in excess of $11 million over your lifetime or be worth that amount when you die. If you are married, and with proper planning, that amount can be doubled.  Any money beyond that will be taxed under the gift or estate tax.  

These days, this tax limit isn’t a big deal unless you have millions saved away in the bank or in investments. However, in years past, the amount was only a few million.

Many more people could reach this when adding up their 401k, business, family farm, or other investments.  Even if the limits for gifting drop with future tax law changes, the items in this article are still valid choices for your estate plan.

Since the limit can change over time, it’s wise to work with a tax advisor who can theoretically do a little fortune telling. For example, the government has given out trillions of dollars in stimulus during the 2020 coronavirus pandemic, which they will have to recoup this money somehow. In the near future, it’s possible that estate and gift tax—as well as income tax—will go up. When advisors foresee this happening, it’s a good time to gift your business.  

Will the business grow or shrink?

When contemplating the options listed on the chart above, you should factor in whether or not the business will grow. If you think the business will grow in the future, transferring it now is a good idea.

Assessing where the business is in its lifecycle is a major factor in succession planning. It could influence the taxes you would pay, whether or not you’d still like to be involved in the business, if you want a recurring income stream, and more.

How will you keep things fair among multiple children?

If you have multiple children, and some are already in the family business while others are not, it can influence how assets are split up. At 415 Group, this is something we run into a lot. And again, the answer can go in various directions.

Many parents want to give their children similar values in business or assets in an effort to be fair. For example, they may hand the business over to their daughter who has been involved with it for over 20 years, while the son is given the building it is operating in or has a 401k transferred over to him.

It’s also possible that one child helped grow the business, while the other went into a completely different line of work. In this case, the family may pass down the business to the one who has been involved for a while and not be as concerned about exact “equality” in splitting up their assets.

Do you want a lump sum or paid over time?

When you sell your business to a family member, you will need to consider how and when you want that payment. You could take it all at once after selling and walk away. Or, you could go the route of an intentionally defective grantor trust (IDGT) to get an income stream over time.

When factoring in paying taxes, you might prefer one way over the other. For example, let’s say your business is worth one million dollars. If you want all of the money at once to invest elsewhere, you’ll have to pay taxes on it at the time of selling. Or, you could go the route of an income stream, and be paid $100,000 plus interest per year for 10 years. You would still have to pay taxes on it, but it would be spread out over time with the “bonus” of interest building up.

Do you want to maintain any control of the company?

Finally, how much do you want to be involved after transferring the business? Many Type-A business owners want to stay involved at some level. Other owners want to simply walk away.

After running a business for decades, it can be really hard to relinquish some control, even if it’s to a family member. Younger generations might want to run the company differently or have a different mindset. Watching them make decisions you don’t agree with can be tough.

It’s possible to hand the reins over to your daughter, giving her a chance to run the business. During this trial run, you can still own voting shares. After some time seeing how it works out, you can make the decision to give her full ownership and walk away. Working with a good attorney and accounting team can define the decisions that the former business owner should still have approval on versus the ones that the next generation should make on their own.

Start planning early

As you can see, there are many decisions that need to be thought through when deciding on a succession plan to gift or a sell a business to a family member. The more time you give yourself to plan, the better.

Strong succession planning is key to the future of your business. Contact us today to get started.