Transferring Ownership to the Next Generation

Family businesses rarely last after the second generation. So, if you want your business to continue to thrive — even after you’ve retired — you need to develop a succession plan for the future. One important step in the succession planning process is determining the best way to transfer ownership interests to the next generation.

All in the family — or not

The first thing many business owners think of when it comes to succession planning is selecting a successor, and your choice likely will have an impact on your ownership-transfer strategies. If multiple family members are competing for the job or if a nonfamily member is best suited to take the reins, conflicts could occur. Allowing family members to participate in the succession planning process will help ensure a smooth transition.

Another thorny issue is how to divide your wealth between family members who work in the business and those who don’t. If you want to divide your estate equally among your children or other family members and you have significant nonbusiness assets, you can leave the business to those who are active in it while still treating everyone fairly.

If most of your wealth is tied up in the business, remember that “equal” distribution of ownership interests isn’t necessarily “fair.” A child who’s spent years helping you grow the company may object to sharing control with family members who weren’t involved. One way to share the wealth without diluting management control is to give voting stock to children working in the business and nonvoting stock to the rest.

From one generation to the next

From a tax perspective, succession planning is critical because the way you transfer the business to the next generation can have significant gift and estate tax implications. You can minimize estate taxes by transferring business interests during your lifetime.

With proper planning, you’ll be able to remove these assets from your estate today without negative gift and estate tax consequences and also avoid gift and estate taxes on any future appreciation in value. But make sure you balance the benefit of reducing transfer taxes against your desire to maintain management control and your need to continue to receive income from the business.

If you’re comfortable relinquishing control over the business, the simplest strategy is to begin making regular gifts of ownership interests, taking advantage of the $14,000-per-recipient annual gift tax exclusion, which was unchanged for 2017, and the lifetime gift tax exemption. The increase in the lifetime exemption to $5,490,000 million that went into effect for 2017 provides a powerful incentive to make lifetime gifts.

Be sure to document gifts of ownership interests with appraisals and business valuations. They can help avoid an IRS challenge down the road.

Other strategies

A more complex strategy to consider is transferring business interests to your family through a family limited partnership (FLP). This can allow you to retain some control over the business and benefit from enhanced valuation discounts. Keep in mind that FLPs are complex entities, and they must be structured and operated carefully in order to avoid an IRS challenge.

Alternatively, you might want to sell the business to family members. By using a self-canceling installment note (SCIN), you can even provide for the buyers’ payment obligations to terminate on your death without adverse tax consequences.

Finally, consider implementing an employee stock ownership plan (ESOP). It’s a qualified retirement plan similar to a 401(k) plan except that it’s required to invest primarily in the company’s stock. (Often the company stock is its sole investment.)

If your business is eligible, an ESOP can be a tax-efficient means of transferring stock to employees, whether family members or others. At the same time, it enables you to remove some of your equity from the business, so you can finance your retirement or create a source of liquidity to provide for family members outside of the company.

Planning is key to survival

Family businesses come and go. Some last for generations; others fall apart quickly. To ensure your family business continues to thrive for decades to come, let us help you to effectively address ownership transfer in your succession plan.  Call us today at (949) 482-1850.

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