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Business Owner Planning

Succeeding in Business Succession

Family business experts estimate that approximately one-third of family businesses will survive to the second generation, 12% will survive to the third, and 3% will still be viable in the fourth generation and beyond*. This proves that whether you plan to retain or sell your business at death, disability or retirement, you need expertise to help you structure an arrangement to maximize the tax and financial benefits to you and your family. Our associates are specialists in business succession planning strategies, including buy-sell agreements (such as stock redemption and cross-purchase agreements), the use of life insurance, grantor-retained annuity trusts and family limited partnerships. We work with you and your advisors to develop strategies that maximize control if you wish, while still allowing the business to smoothly transition whenever you choose.

*Facts on Family Business in the U.S., from the Family Firm Institute,

Buy-Sell Agreements

A buy-sell agreement is a contract between two or more business owners that outlines the terms of ownership transfer in the event that an owner retires, becomes disabled, or dies. Corporate buy-sell agreements are typically structured in one of three ways: a stock redemption, a cross purchase, or a "wait and see" agreement.

Stock Redemption

This type of buy-sell agreement occurs when the corporation buys back stock from the shareholder or a deceased shareholder's estate. Typically, the estate receives cash in exchange for the stock.

Cross Purchase

This type of buy-sell agreement calls for the remaining shareholder(s) to buy the stock of the departing or deceased shareholder. To fund such a plan, stockholders typically buy life insurance policies on each other. The surviving business owner (not the corporation) purchases stock from the decedent's estate.

Gifts of Corporate Stock

Making a lifetime gift is often the most effective way to reduce estate taxation. Economic necessity will temper one's willingness or ability to make significant lifetime transfers of wealth. It is common practice in the design of a financial plan to model the asset base and cash flow requirements of a potential donor before making significant gifts. This is a simple, but practical step used to give up control of the assets.

Gifts can be made outright or in trust. The basic benefits of gifting include:

  • Shifting the income and growth of an asset out of a higher income tax bracket;
  • Shifting growth out of a high estate tax bracket;
  • Tax leverage. Even though the estate and gift tax rates are the same, the calculation process favors lifetime transfers (see the table above);
  • Allows a "testing ground" for future management skills.

Life Insurance

Life insurance is a practical and popular planning tool. The reasons for this relate to the basic mechanics of an insurance policy. Premiums are priced relative to policy proceeds. For a married couple, it is common to use second-to-die coverage for estate liquidity needs. But, if the insured owns the coverage or has incidents of ownership, the proceeds are subject to estate tax. Therefore, it may be wise to consider positioning life insurance owned outside of the estate in order to avoid inclusion of the proceeds for tax purposes. Placing life insurance in an irrevocable trust or ownership by adult children are ways to accomplish this.

In addition, life insurance is typically used to fund buy-sell agreements. In a stock redemption, the corporation owns a policy on the life of each shareholder. In a cross purchase, each shareholder owns a policy on the life of each of the other shareholders.

Private Annuities

A private annuity may be effectively used in family situations where a parent wants to transfer an asset, such as a business interest, to the next generation, while minimizing estate taxes. Typically, the parent sells the asset to the child. In return, the child promises to pay the parent an income for life. This is a legally enforceable contract right, but unsecured. Since the payments to the parent terminate at death, the annuity generally has no value,and therefore, is not included in the parent's estate. To be successful, the present value of the annuity payments has to be equal to the fair market value of the asset being sold. The child takes the risk of the parent living past life expectancy. The parent takes the risk that the child will not meet the current payment schedule. For example, at age 65, the parent has approximately a 20-year life expectancy. Assuming a federal discount rate of 5.8%, the annual annuity generated by property worth $100,000 is $10,129.

This is a hypothetical example only; it is not our position to give legal or tax advice.

Family Partnerships

A family partnership may be used to shift both the income tax burden and the appreciation of assets from parents to children or other family members. However, the benefit of income shifting to children under age 14 is limited, since unearned income in excess of $1,500 (as indexed for 2001) generally will be taxed at the parents' income tax rate. It is also possible to transfer business interests to children and retain control by retaining the general partnership interest. It is even possible to receive a discount for gift tax valuation purposes if the partnership interest transferred is a minority interest. Discounts also can apply due to the lack of marketability of partnerships. Any appreciation on transferred interests should not be included in the transferor’s estate, assuming a valid partnership has been established.