Why family business owners fear succession planning

FROM  http://www.naplesnews.com/



Can you guess what area in estate tax planning causes the most anguish (fear)? Hands down it's business succession.

A little side note: Last year I worked with a business owner in Vermont, which accomplished a long-sought-after goal for my practice: Creating an estate plan for a business owner in each of the 50 U.S. states.

All closely held business owners share a common future (no exceptions): Someday they must pass the management baton.

Whether the reason for stepping down is age, illness, a desire to travel or play more golf, give into your wife's pleading to "spend more time with me," or a host of other reasons, the fear factor is almost always a player.

Following are the three questions (yes, there are more) that lead the unwelcome-fear-factor parade:

1. How high will my income tax/capital gains taxes be if I sell to the kids (or employees) now?

2. If I don't sell now, how much will the increasing business value increase my estate tax liability?

3. What's the number one fear? Control! Rarely does a business owner want to give up control.

About one out of every three business owners who call me to do their estate plans own 51 percent (or more) of their business. Why 51 percent? Fear of losing control. Worst of all, few professionals know what to do to calm the fear of losing control. Read on, to learn the simple solution.

Following is a true-life example of a reader/business owner (Joe) of this column. Joe is married to Mary. His son Sam works in the family business (Success Co.). David (age 36 and the key employee) — not family — has natural business instincts, is respected by the employees and helps Joe run Success Co.

Let's list Joe's fears, which we have turned into goals.

1. Keep control for as long as Joe lives. Joe owns 51 percent of the stock of Success Co. (an S corporation). We recapitalized (created voting and nonvoting stock) Success Co. so Joe now had 51 shares (out of 100) of voting stock and 5,100 (out of 10,000) shares of nonvoting stock … a tax-free transaction. The strategy is for Joe to keep the voting stock (and control) to the day he dies. The nonvoting stock will be transferred to Sam.

2. Transfer (sell) Success Co. to Sam (freeze the value). Sell the nonvoting stock to an intentionally defective trust (IDT). The tax beauty of an IDT is that Joe legally avoids capital gains tax on the sale.

An IDT wins taxwise over a typical sale to Sam. Why? The huge tax burden on Sam for a typical sale disappears. For example, if the income tax rate is 40 percent (state and Federal combined), Sam must earn about $167 dollars, pay $67 in income taxes to have $100 left to pay his dad. With a $4 million price, Sam must earn over $6.5 million to pay Joe the $4 million.

Ouch! So bless the IDT.

3. Make sure that Joe and Mary can maintain their lifestyle for as long as they live.

Sam does a good job as one of 80 employees at Success Co., but does not have the skills to manage the business. What to do about management?

David, the key employee, is the answer. We created a non-qualified deferred compensation plan that gives David the benefits of ownership — a share of the profits, gets paid if he gets sick (covered by insurance) and $1 million (again insured) for his family if he gets hit by a bus … all without owning any Success Co. stock.

An interesting note: Success Co. has grown in sales and net profit since David took over assures maintaining lifestyle for Joe/Mary.