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Business owners well-advised to formulate a transition plan

The short-term demands of running a business often distract business owners from the long-term importance of developing a comprehensive transition plan. This includes proper planning for protecting and preserving the future of their business.

For business owners, the goal of preserving wealth is not enough. Business owners must prepare their businesses for the legal and financial aftermath of their retirement or death. If they do not, they are exposing their families to increased tax liabilities and their businesses to undesired acquisitions, disputes of business ownership and/or failure.

Transition planning should begin as early as possible. According to the Small Business Administration, some transition consultants recommend a three- to five-year plan, while still others counsel owners to create a 10- to 15-year plan. By allowing sufficient time for planning, business owners can evaluate potential successors in various roles and determine whether these individuals have the commitment, maturity and drive necessary to succeed.

Owners should consider the following when preparing the plan:

  • Can the business be transferred?
  • To whom should the business be transferred?
  • When should the business be transferred?
  • How should the business be transferred?

To ensure continuity, business owners must have a well-thought-out plan that considers taxes and insurance.

Owners can consider timing the transfer of a business during their lifetime. This option allows the opportunity to consult with the successor—and may help reduce the risk of a discounted sale of the business. In addition to starting early and communicating openly and clearly about the transition plan, business owners should seek professional support. They should involve a strong professional advisory team consisting of an attorney, a certified public accountant and a banker. This team can provide the business owner with information about the various transfer options that exist, including:

  1. Gift of the business to:
  • Family limited partnership or LLC; or Delaware Directed Trusts.
  1. Sale to third party options, which can entail:
  • Outright sale;
  • Installment sales;
  • Sale to defective trust;
  • Self-canceling installment notes; and
  • Sale in exchange for private annuity.
  1. Sale to employee, which may involve:
  • Outright sale;
  • Installment sale; or
  • Employee stock ownership plans.
  1. Sale to co-owner. These agreements are often called buy-sell and are triggered by certain events such as death, disability, divorce or retirement. They include:
  • Cross-purchase agreement (with or without escrow or trust);
  • Entity purchase plan; and
  • Hybrid (wait and see) approach.

Role of insurance

Another option for owners is to have a potential successor in mind to operate the business should they become unable to do so. If the business has one or more co-owners, a buy-sell agreement is a consideration. This agreement states that upon the death of any owner, their interest is automatically purchased by the other owners. This arrangement can ensure that beneficiaries of the deceased owner (including spouses or other family members) don’t unintentionally become owners. Key person life insurance can be purchased as a way to fund a buy-sell agreement and provide the necessary liquidity.

In the event a business owner dies, key person insurance provides a tax-free death benefit. This helps businesses fund the recruitment, hiring and training of a new key executive, as well as remain solvent during the transition to new leadership.

Key person insurance assures customers and creditors of business continuity. The corporation purchases the insurance policy on the key employee’s life, becoming the owner, beneficiary and payer of premiums. After the death of the employee, the corporation receives the total death benefit, tax free.

Long-term care insurance can also protect a business owner’s assets when the owner can no longer be independent. This type of insurance may be less costly for a business owner under a group discount plan than when purchased individually. Purchasing this coverage through the corporation may bring a significant tax advantage.

Estate planning

Planning for taxes is also an essential part of any strategy as estate taxes are among the steepest and most severe taxes levied. In 2017, the federal tax rate on estates is 40 percent after the lifetime exclusion of $5.49 million for an individual and $10.98 million for a married couple.

Trusts are often effective vehicles that allow you to reduce the value of your taxable estate and save tax dollars. Some options include but are not limited to the following:

  • Irrevocable life insurance trust;
  • Grantor retained annuity trust or grantor retained unitrust; and
  • Charitable remainder trusts.

No single option exists to transfer the control of your assets or to help minimize the tax burden on an estate. Trust officers, financial planners, attorneys, accountants and insurance agents with many years of estate planning experience should work as a team to help you develop a plan that fits your family’s future needs and your wishes.

When it comes to estate planning, Benjamin Franklin’s adage “nothing is certain except death and taxes” couldn’t be more appropriate. Business owners who establish a comprehensive estate plan not only secure their wealth and the wealth of their heirs, they also secure the legacy and future of the businesses they have worked so hard to establish.

James Barger is president of KeyBank’s Rochester Market. He may be reached by phone at (585) 238-4121 or email at james_r_barger@keybank.com.

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