Making Family Business Transition Plans A Success
A plan of business continuity is a crucial element of any business owners estate plan. In our world of uncertainty, it is more important than ever for business owners and their advisors to develop comprehensive plans for passing the business on when death or disability occurs.
This critical planning becomes even more complex when the business in question is family-owned.
When dealing with family-owned businesses, the focus is on minimizing the cost of keeping the business in the family, with one of the principal expenses being the gift and estate tax payable on business interest transfers to family members who have been identified as successor owners.
For many years, small businesses, especially family businesses, lobbied heavily for the repeal of estate taxes to relieve the tax burden when passing the business to their heirs. While the Economic Growth and Tax Relief Reconciliation Act of 2001 did not guarantee the repeal of estate taxes in 2010, it did provide, in general, for an estate tax reduction with some immediate relief and the balance phased in over the next few years.
However, the Act also repealed for estates of decedents dying after Dec. 31, 2003 the qualified family-owned business deduction that was originally enacted as part of the 1997 tax legislation. As a result, estate taxes still need to be addressed to plan for a shorter-term tax liability, while also planning for the possible reappearance of the estate tax in 2011.
Failure to plan for an efficient and effective ownership transition will result in the business having to assume an additional financial burden at a difficult time when it has just lost not only a key employee, but the leader of the organization.
For advisors in the family business planning market, there are 6 key questions that need to be addressed in the planning process.
1. Should the business remain in the family or should it be sold?
Often this question is not asked because it requires the business owner to make an objective assessment of a childs ability to manage the business. This is difficult because of the owners emotional ties to both the family and the business. If this issue is not addressed, however, the result may be a business being retained in the family when it would be better for the family, as well as for the business, if it were sold, with the proceeds distributed to the heirs.
2. What objectives should be part of a business owners estate plan when the business will stay in the family?
The plan should create a synergy among three potentially competing objectives.
One is the desire to pass control of the business to those children active in the business. The second goal is to provide for the financial well-being of the business owner and spouse, separate and apart from the business. Finally, there is an objective to treat fairly the children who are not active in the business.
An advisor and the client will know when a well-prepared plan is in place if it achieves these three objectives.
3. Should the owner leave the business to a surviving spouse to defer federal estate taxes until his or her death?
The marital deduction defers federal estate taxes on assets passing to the surviving spouse or into certain trusts designed to benefit the surviving spouse. These assets will then be subject to federal estate taxes as part of the surviving spouses taxable estate.
It is not uncommon to find a business owner leaving the business to his or her spouse in order to take advantage of this estate tax deferral. Whether this is advisable depends on the degree of involvement the spouse has in the management of the business. Leaving the business interest to a spouse who has no working knowledge of the business could jeopardize its ongoing success and threaten the familys financial well-being.
It could also cause severe discord if the spouse assumes a management role formerly performed by the children or other key employees. Even if these obstacles are overcome, the future growth of the business will be exposed to estate taxes as part of the surviving spouses estate, adding to the cost of transferring the ownership to the next generation.