Wealth of Knowledge - Spring 2012 - Keeping it in the Family

For many family-owned businesses, the transfer of a business to the next generation gives rise to two unique sets of challenges.  The transfer of wealth and the transfer of power to the next generation are both crucial to the long term health of a family-owned business and the family itself.
The burdens of estate tax can cause hardships on both a business and a family.  Without proper planning, there may not be sufficient cash to continue supporting the family’s lifestyle while paying Uncle Sam.  By taking advantage of the current estate tax laws which may not be around forever, this burden can potentially be mitigated, preserving the family’s wealth and the strength of the business.

Under current law, United States citizens can make lifetime gifts free of tax up to $5,120,000.  For a married couple that means more than $10,000,000 can be transferred free of gift and estate tax!  With proper estate planning, a substantial portion of a family business’s value can be transferred to the next generation without paying a federal transfer tax.  Future appreciation can be shifted to the next generation as well.

The current law is set to expire on December 31, 2012 and in 2013 the exemption is scheduled to revert back to $1,000,000.  The estate tax is a hotly contested political issue and we will likely not see a resolution to this issue before November’s presidential election.  While no one can accurately predict what Congress will decide, taxpayers can take advantage of the current law by making transfers before year end.

For example, if Mom and Dad own an S corporation valued at $40,000,000, Mom and Dad can elect to use their lifetime $5,000,000 exemption and make transfers to each of their two adult children who work in the business.  By applying discounts for lack of marketability and lack of control, Mom and Dad can transfer approximately $14,000,000 to their children while making a gift for gift and estate tax purposes of less than $10,000,000.

  • Discounts for lack of marketability and control = $14,000,000 x 30% = $4,200,000
  • Discounted value of stock = $14,000,000 - $4,200,000 = $9,800,000
  • Value transferred to each child = $7,000,000
  • Value transferred to each child for gift and estate tax purposes = $4,900,000
  • Gift tax paid upon transfer (assuming no previous gifts) = $0

In addition to the savings realized above, 35% of any future appreciation in the value of the business will escape inclusion in mom and dad’s estate.

In the illustration above, transferring a minority interest in the business allows Mom and Dad to maintain control.  In some instances transferring a majority of the stock makes sense.  By transferring nonvoting stock or through the use of trusts, Mom and Dad can maintain control over the business.

However, there comes a time in the life of every family business when transfer of control is necessary.  Maybe Mom and Dad would like to step back and begin travelling, or health reasons dictate a transfer of control to the next generation.  Maybe it’s just time for the children to take over.  Whatever the motivation; relinquishing control is not easy.  Determining who should be given that control can be even more difficult.

“I love you all the same.”  This was a phrase my parents uttered often when my siblings and I were younger.  While a parent’s love may be distributed equally, the talent and capability of running a business may not be.  Parents need to recognize that their children have different strengths and weaknesses, and that it’s in the best interests of all of their children to do what makes the most sense for the long term success of the business.
It may also be in the best interest of the business and the family for one person to be in charge.  By making these decisions now, and involving the family in the decision, explaining the reasons and asking the children what they want, future conflict can often be avoided or at least uncovered now.  Power struggles are not good for the business or the family. 

Like most things in life, the transfer of wealth and the transition of control to the next generation benefit from planning and proactive decision making.  While these are difficult decisions and conversations to have, taking advantage of the current estate planning environment should provide extra motivation to tackle this important task.  At the end of the day the goal is to keep the business in the family.

A Wealth of Knowledge - Spring 2012 Issue 

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