With recent activity in the private
equity arena, business owners
have been placing considerable emphasis on structuring their companies
to maximize the price of an ultimate sale.
However, smart business owners should
begin to position themselves before reaching the top of their game so as to structure
their companies for sale from an estate-planning perspective. Tax law developments in recent years, including capital
gains and dividend rate reductions, make it
imperative for business owners to examine
current estate planning so as to minimize
the tax cost of transferring the business
and maximize its value to the retiring
owner or the next generation.
Smart Business asked John Brentin, a
partner at Porter & Hedges LLP, how business owners can leverage their wealth,
retain their monetary gains and prepare
their companies for sale.
Why should business owners be concerned
early on with transition planning?
It is inevitable that for every business
owner, at some point a transition will occur
— by sale, incapacity or death. If there is
no heir-apparent, it is then necessary to put
in place a mechanism to allow the most
appropriate person to carry forward the
vision of the founder. Likewise, if there is
no one of the next generation capable or
with a desire to carry forward the business,
a lack of early planning can lead to significant tax liability should a transition be
forced upon business owners. In those
unfortunate circumstances where there is
a death of the owner, without advanced
planning, the business can be adversely
affected, both operationally and from a
cash flow perspective.
How can business owners minimize estate
and gift taxes?
The current reality is that there is no
repeal of the death tax forthcoming. At
rates approaching 50 percent and a current
exemption of only $2 million, planning is
critical. Since the estate and gift tax is
applied to the value of assets being transferred, successful planning seeks ways to
transfer wealth while minimizing the valuation of retained assets that will be included in the estate. For those business owners
who desire to minimize estate taxes there
are several available options. Currently, the
annual gift tax exclusion amount is
$12,000. This means that a husband and
wife can now give $24,000 to as many individuals they care to benefit every year. If
they transfer interests in the family business, they can leverage the gift using a qualified appraisal of the interest that is appropriately discounted for lack of control and
marketability. Another option is to transfer
those interests into a trust established for
family members to keep the business within the family for succeeding generations. If
large transfers are desired, using a grantor
trust may allow them to sell up to their
entire business interest in exchange for a
promissory note without paying any
income tax on the sale.
Why are control, timing and form of business
so important to transfer planning?
Control of a business has a great deal to
do with the concept of valuation. Further,
since our entire transfer tax system is
based on value, timing also plays an integral role. Finally, not all forms of doing
business are created equal. Today’s business owner has a wide array of choices,
and some structures are better suited than
others to facilitate a transition of ownership.
From a timing perspective, the ideal
times to begin a transfer of ownership
process are at the initial start-up or during
an economic downturn. The value of the
company is lower, which is a benefit for
valuation purposes in tax planning. Based
on the options available to minimize estate
taxes during such a period, an owner has
the ability to retain control while putting in
place a mechanism to facilitate the transfer
of the value to the next generation.
Finally, formulating a succession plan
often reveals that the original structure of
the business entity may no longer be
appropriate. Recent amendments to Texas
statutes and changes in federal tax law
make it easy to convert from one form of
business to another. A successful plan will
always assess and isolate risks and potential liabilities. If a particular facet of the
business operation produces a greater risk,
it may be appropriate to form an additional entity to conduct that part of the business operation.
How flexible should you be with your transition plan?
It is wise to plan for all contingencies and
allow for flexibility in your transition plan,
knowing that every circumstance planned
for will not actually happen. Building in
flexibility allows those left in charge to
react to unforeseen conditions. A transfer
plan that reacts to the ebb and flow of the
business world can help alleviate the worries and assure the continued success of
the enterprise.
JOHN BRENTIN, a partner at Porter & Hedges LLP, is in charge
of the firm’s wealth preservation practice. Reach him at (713) 226-6663 or [email protected].