In working with advisors on exit planning strategies for business owners, I find two common concerns. The first is focus. “Succession planning” and “business continuation planning” are terms advisors commonly apply to a process that, in real life, is much more egocentric.
Most business owners are primarily focused on how they can exit their business successfully. To the extent that means the business will continue, partners will take over and employees will stay on, this may be a benefit. But, exiting successfully is the goal and focus for most business owners.
The second concern is how some advisors apply old techniques to new situations, particularly regarding the business’s legal form. Many advisors apply exit planning strategies designed for C corporations to S corporations and LLCs.
Most companies filing a corporate income tax return are S corporations; it is time to reevaluate the recommended exit planning strategies. Three examples of non-traditional strategies demonstrate some new techniques available to business owners.
S Corporation Stock Redemption
Traditionally, the preferred method for selling an owner’s business interest was a cross-purchase agreement. The agreement allows small C corporations to overcome concerns related to family attribution rules, alternative minimum tax and the lack of increased basis for the remaining owners.
With S corporations, these concerns rarely apply. There is no corporate AMT; the family attribution rules generally have no adverse affect. Also, owners can secure increased basis for surviving shareholders in S corporations through coordinated planning with life insurance and short year tax elections.
Life insurance proceeds paid to an S corporation increase the basis for the shareholders. A planning goal for S corporations is to have all the basis increase from life insurance proceeds allocated to the surviving shareholders.
The buy-sell agreement can specify that at an owner’s death, the business will buy the stock for a note. Once redeemed, the surviving shareholders close the tax year for income tax purposes.
Only then do they collect the corporate-owned life insurance proceeds and pay off the note to the decedent’s estate. With a cash basis S corporation, this transaction can allocate the entire life insurance basis to the surviving shareholders.
There is no adverse tax affect for the deceased shareholder. Yet the technique can save the surviving owners significant income taxes when they later sell their interest in the business.
Leveraging the Business Continuation General Partnership