Individuals who own substantial family businesses have a unique opportunity to do succession planning while maintaining family harmony and saving taxes. The situation, however, brings to mind that old adage, “You don’t know what you’ve got till it’s gone.” That’s because interest rates aren’t going to stay low forever, and elements of the government want to curtail or eliminate a couple of planning ideas that work exceptionally well together in a low interest rate environment.

The techniques I am referring to are sales to an irrevocable grantor trust and the establishment of family limited partnerships. Generally these ideas are associated with tax-oriented estate planning. But what people overlook is the role they also play in succession planning, which can preserve not only the business, but also family harmony.

I am sure some of your customers were tired of hearing about the lost opportunity that would happen if they did not make gifts last year and the applicable exclusion dropped from $5.12 million to just $1 million. Well, it didn’t drop, so what’s the big deal? The big deal is that your customers are playing poker and betting the store on the next hand the government deals. On that score, remember that, in the long run, the house always wins because the House (of Representatives, that is) makes the rules.

See also: No more estate planning excuses

So what are the potential consequences of interest rates rising and losing the sale to a grantor trust and family limited partnership techniques? The answer lies in the fact that once you cross the gift tax threshold ($5.25 million for singles and $10.5 million for married couples), any additional transfers of family business interests to future generations have to be structured as something other than a gift to avoid the gift tax.

Keep in mind that people are very unlikely to want to make transfers to family members if they have to pay a 35 percent gift tax on the transfers. And this is where structuring the additional transfers as a sale to a grantor trust at a low interest rate comes into play. The reason is that the cash flow from the business is going to be used by the trust to pay the notes plus interest that are funding the sale. Consequently, if the interest rate is low, the cost of the sale to the trust is reduced, and the cash flow of the business can more easily service the debt.

With that in mind, another step to make the sale to the trust even more affordable is to restructure the business as a family limited partnership before it is sold to the trust. This is because the partnership structure permits the sales price to the trust to be reduced to reflect discounts for lack of marketability and lack of control. In any case, it is easier for the trust to purchase the business using the business’s own cash flow if the sales price is discounted and the interest rate on the notes is low.

Of course, all of this depends on clients acting on their planning opportunities before things change. As the Greek philosopher Heraclitus said, “The only permanence in the world is change itself.” This means that if they really care about doing what they should to take care of themselves and their families, they had better move on these opportunities while they last. Otherwise, they may be leaving future generations nothing but the memory of what they had.

 

For more on estate planning, see:

The $5.25 million question

5 March Madness estate planning tips

Adding flexibility to estate plans