The Philadelphia Business Journal’s recent article, “6 savvy tips on business exit strategies for family businesses,” provides us with just that: six tips for family business exit strategies. Let’s look at each of these options:
Last Will and Testament or Trust. If you want to own your business until you pass away, you can bequeath your business to your named beneficiary in your will or in a trust. Those who receive the business will inherit it with a basis equal to its fair market value at the time of your death. If they choose to sell the business at a price close to that date of death value, then there will be very little or no capital gains taxes on the sale. You should bear in mind that the entire value of the business will be included in your estate for estate tax purposes.
A Lifetime Gift. Another option is to make gifts of your business interest during your lifetime. From an income tax perspective, you typically won’t be subject to income taxes on any gain in the property. However, the people who receive the gift will have a basis equal to yours. Therefore, if the recipient later sells the gifted interests, they may recognize a greater amount of gain than had you bequeathed the business to them in your will.
Sale. Of course, you can always sell your business. Capital gains are generally recognized on the sale for the seller. If the sale is for a note, a gain is generally recognized annually over the term of the note. If any remaining balance exists at the death of the seller, the balance can be bequeathed by the seller and the basis of the remaining part of the business will be adjusted to its fair market value. This will minimize or eliminate taxable gains. Gift taxes may also be possible, if the price paid in the sale is less than the value of the business interest sold.
Redemption by the Corporation. Instead of selling your business to an individual family member, you can have the interest redeemed by the corporation itself. For the seller, the tax situation is like that of a sale to the next generation. However, a stock redemption eliminates the need for the next generation to find the cash that’s already been taxed, since the money for the purchase comes from the corporation. In many cases, the corporation will be the owner and beneficiary of a life insurance policy on you, as the seller, to provide funds to redeem your interest. For regular C corporations, there may also be other tax consequences for family-owned businesses, like “family attribution.” Talk to an attorney about this issue.
Recapitalization. Rather than transferring all of the business, you may recapitalize it into two classes of stock and keep the class that gives you income. You can transfer the class of stock that’s entitled to appreciation in the value of the business. This lets you keep a stream of income from the business and also operating control. It also avoids current income taxes, and, subject to the Chapter 14 valuation rules, may allow some of the future appreciation in the value of the business, to be transferred to the next generation free of estate or gift tax.
Buy-Sell Agreement. This is an agreement among the owners of a business for the eventual disposition of each owner's interest. There are several ways to structure this agreement. One is the “cross purchase” method, where each co-owner agrees to buy out the interest of a departing owner. The “entity purchase” method makes the company itself buy out the departing owner (called a “stock redemption” method for corporations). There’s also the “wait-and-see” method, which is a hybrid that lets the company and owners defer the choice between cross purchase and entity purchase, until a triggering event. This lets the owners and the company respond to financial conditions and tax issues, when the triggering event occurs.
Be sure to consult with legal and tax professionals, since there are several tax issues that can arise, based upon the planning technique you use.
Reference: Philadelphia Business Journal (August 31, 2018) “6 savvy tips on business exit strategies for family businesses”