Succession planning enables the transition of leadership roles to support the ongoing operations of a business. Business owners should be thinking about their succession plan throughout their lives, but as they approach retirement it becomes even more important. Succession planning can take several different directions including the sale of the business.
It is important to note that tax considerations will play an important part in determining the direction an owner will decide to take when creating this plan. A succession plan created three years ago may not be viable today because the tax code may have changed or there may be expiring provisions.
What Does Retirement Look Like?
In this article we will explore some of the options available to a business owner who is considering retirement. At the foundation of retirement planning is the question, “What does retirement look like for this owner?” Will the owner leave the business completely or continue to work in some capacity, perhaps on a part-time basis? For example, some owners continue to participate in their business, such as taking on the role of a consultant.
If the decision is to leave the business completely, will the business be transferred to family member or sold to the highest bidder? A business valuation must be completed to determine the value of the company. Once that’s done, there’s a key question that must be addressed: what is the tax exposure from the sale or transfer of the business?
Key Considerations
Some of the areas business owners should consider when creating a succession plan include the gift and estate exclusion limits, capital gains tax rates, state tax laws and trusts.
When planning the transfer of ownership, the gift tax exclusion should be considered. The 2024 gift tax limit is $18,000 for an individual, $36,000 for couples. If the gift tax limit is exceeded the gift-giver is required to file a form 709. Gift-givers who exceed the annual gift tax limit may not be subject to the gift tax if they have not exceeded the lifetime gift tax exemption, which is $13.61 million in 2024.*
With the sale of a business, owners must consider the capital gains tax liability. Capital Gains tax rates can be as high as 20%* depending on the period over which the company was helped, and the amount of gains from the sales. A well-crafted buy-sell agreement can assist with minimizing the recognized capital gains. A buy-sell agreement is a legal contract that states the terms of the sale and/or transfer of a business. State tax law will also play a key role. Some states have more favorable laws for income and capital gains tax.
Ask About a Trust
Business owners should consider setting up a trust as part of their succession planning. One trust that can be particularly beneficial, especially if the owner needs income during retirement, is the grantor-retained annuity trust. The grantor-retained annuity trust allows the grantor (business owner) to set up an irrevocable trust, whereby the grantor retains the right to receive annuity payments for a specified period, after which the business interests are transferred to the beneficiaries with nominal tax.
Owners should always ponder the future they desire for their company as they grow and structure the business in a way which will facilitate their plans. With all the considerations that business owners must address when creating a succession plan, it’s wise to contact a tax professional to assist with minimizing the tax liability for both the owner and their heirs.
(*Source irs.gov)
Founder and CEO of LEK Management Inc., Lynn Karam has two decades of experience in finance, operations, and strategic planning. Karam is an Enrolled Agent authorized by the United States Department of the Treasury to represent clients who are undergoing an audit and to negotiate with the IRS on her clients’ behalf. Her success rate in resolving even the most challenging of IRS scenarios has become the cornerstone of her success. As CEO, Karam uses her financial expertise to establish sustainable strategies that result in significant business growth for her clients.