Business Succession Brings A Need for Financial Planning
By: Utah Business - January 01, 2017
Are you staring at millions of dollars in taxes if you sell your business? Today, 78 percent of business owners have no formal transition team in place; 83 percent have no formal transition plan in place; and 49 percent have done no planning at all. A lack of planning can cost many business owners millions of dollars in income tax upon the sale of their businesses. Not only can the damages of poor planning affect what one pays in income tax, but also poor planning negatively impacts families, employees, and business owners themselves.
By reading this business article prepared by a financial analyst, business owners will (1) learn what financial planning consists of and its various aspects and (2) why detailed planning is essential in preparation for the sale of a business.
What Does Succession Planning Consist Of?
Three aspects of business succession planning must be taken into consideration: (1) management; (2) ownership; and (3) transfer taxes. Each of the three main concepts must be addressed in preparation for the sale of a business to reach the personal and financial goals of the business owner.
While management is often thought of as an internal team within the firm that manages the day-to-day relations of the business, outside management is key to succession planning. Hiring an experienced team of advisors will help ensure that business owners are prepared for the intense change in lifestyle that comes with acquiring large personal wealth. As will be discussed later, connections with financial advisors can save millions of dollars for a business owner. A well-suited professional advisor can help to manage tax-related planning strategies, future generational planning, and assets for further investment.
With the sale of a business comes concern for who will be heirs of what is gained. Many business owners would prefer the children receive the proceeds equally while others would have more complex agendas in mind. Regardless of what the goals of business owners may be, professional advisors have the solutions to complex concerns.
Progressive income tax brackets put the highest earners at a rate of 39.6 percent. Federal gift tax is 40 percent and estate tax rates are now at 40 percent for any given amount above the individual exclusion of $5.45 million. Failure to plan in advance may mean personal goals are lost alongside the money being taken by the IRS.
Why is Detailed Planning Essential in Preparation for the Sale of a Business?
Allow the numbers to do the talking. The following is a real-life case study of a business sale. Company ABC had an S. Corp. asset sale (net of debt) of $70.0 million. The income tax due prior to any financial planning performed by Knox Capital Advisors (KCA), a boutique wealth management firm based in Salt Lake City, Utah, was $23.3 million. Further, the estate tax due at death was $17.6 million. KCA used the following planning strategies to minimize federal income and estate tax: (1) sale to an Intentionally Defective Grantor Trust; (2) 1031 Exchange; (3) charitable contribution to a one-year Charitable Remainder Trust (CRT) coupled with a Donor Advised Fund (DAF); and (4) 20-year CRT. Also, a note as to the Purchase Price Allocation (PPA)—when a company sells its assets in a business sale transaction, as was the case in this case study, the way in which the purchase price is allocated to the individual assets may significantly impact the taxes to be paid. The financial advisor was engaged before the negotiations were undertaken relating to purchase price and its allocation. In this case, a greater amount of the purchase price was allocated to intellectual properties and away from allocations to equipment that changed what would have been taxed as depreciation recapture to long term capital gain. The rate differential alone from the change in purchase price allocation resulted in tax savings estimated at $3 million.
The following list shows savings of $11.7 million by using the previously listed strategies.
- 1031 Exchange: $0.8 M
- Short Term CRT/DAF: $1.9 M
- Long Term CRT: $6 M
- PPA—Equipment vs Intangible: $3 M
- Total Income Tax Benefit (LT CRT deferred but tax due on CRT payments): $11.7 M
The following list shows savings of $9.9 million by using other complex estate planning strategies.
- Pre-transaction valuation of NV shares (30% discount on $44 M): $5.3 M
- Income Tax Due by Grantor / through asset owned by Trust for heirs: $4.6 M
- Freeze effect (arbitrage above mid-term AFR): ??
- Total Estate Tax Benefit ( + growth and future income tax payments): $9.9 M
With the assistance of professional advisors, companies like ABC can save millions of dollars in tax. One may ask, “Why should I hire professional financial advisors in preparation for the sale of a business?” Does $21.6 million dollars answer that question? Savings of this magnitude require planning in advance of the sale. As the great Benjamin Franklin said, “If you fail to plan, you are planning to fail.”
Business owners approaching the sale of their businesses are selling more than just companies; these businesses are the owners’ pride and joy—additional children they have nurtured and helped grow. Even more important than the business being placed into new ownership is the people this transition will impact. Certainly, money is not the only thing that matters in life, yet when millions of dollars are owed to the IRS, lifestyles are completely changed. Minimizing the tax burden may not be a driving reason to do great planning, but it is certainly one of many reasons. Business owners owe to themselves, their employees, and their families adequate succession planning prior to the sale of the business. In doing so, millions of dollars can be saved, family planning needs can be met, and life can continue in peace after the sale of a closely held business.
Article source: Utah Business
** Disclaimer Required by IRS Circular 230** Unless otherwise expressly approved in advance by the undersigned, any discussion of federal tax matters herein is not intended and cannot be used 1) to avoid penalties under the Federal tax laws, or 2) to promote, market or recommend to another party any transaction or tax-related matter addressed.