Many people who seek estate planning advice are the owners of family businesses. As such, one of their critical concerns is how to pass the business on to the next generation. Consider this hypothetical. George, age 63, is the sole shareholder of Brick By Brick, Inc., a corporation that specializes in building structures for commercial and residential use. George’s daughter, Julia, is actively involved in the business and is fully prepared to take over the company. As George recognizes he cannot run the company forever, he is thrilled to find out that Julia wants to begin taking over the business. George, however, is concerned with needing sufficient cash flow to support him through retirement.
Brick By Brick is valued at $20 million. George has a basis in Brick By Brick of $100,000. George could sell the business to Julia, but George would be liable for tax on a $19.9 million capital gain immediately. Another method would be for George to sell the business to Julia in an installment sale over 10-15 years. This method will successfully transfer the business to Julia and will provide George with a steady stream of income for the remainder of his life. However, payment of the purchase price for a 10-15 year period, without a gifting component, on that valuation could be burdensome. What if George wanted to sell it for $10 million, but didn’t want a gifting component to the transaction?
Consider the option of establishing a Charitable Remainder Trust (“CRT”). By utilizing a CRT, George can provide retirement security to himself, transfer ownership of the business to Julia with minimum transfer and income tax liabilities, all while satisfying his philanthropic goals.
To illustrate, George could create a CRT and reserve the right to receive an annual percentage, say 6%, of the fair market value of the assets of the trust for his lifetime. To fund the CRT, George transfers 95% of his Brick By Brick shares. By creating and funding the trust, George receives an immediate charitable income tax deduction. George’s remaining 5% of Brick By Brick is worth $1,000,000. After applying a 30% discount for lack of control and marketability, George could gift the shares to Julia with a gift tax value of $700,000—well within George’s gift tax exemption.
Examining only one of the techniques to transfer majority stock to Julia, the board of directors of Brick By Brick can subsequently extend a redemption offer to all shareholders—Julia and the CRT—at the fair market value of the shares. The CRT trustee will accept the offer, and as a result, the CRT will be left with the fair market value of the shares to continue making investments, and Julia will be the sole owner of Brick By Brick, without incurring gift tax. As George receives his unitrust payments, the gain will “leak” out to him over time. However, if George passes away before the entire gain is paid out, the balance of the gain is effectively not recognized.
With careful planning, you can choose an option that makes the most sense for your business, your family and your long-term goals. If business succession planning interests you, please feel free to contact Schneider Downs.
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Material discussed is meant for informational purposes only, and it is not to be construed as investment, tax, or legal advice. Please note that individual situations can vary. Therefore, this information should be relied upon when coordinated with individual professional advice.
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