There are many estate planning tools you can use to transfer your business. Selecting the right one will depend on whether you plan to retire from the business or keep it until you die.
A more sophisticated business succession tool is a grantor retained annuity trust (GRAT) or grantor retained unitrust (GRUT).
Transferring Your Family Business
As a business owner, you're going to have to decide when will be the right time
to step out of the family business and how you'll do it. There are many estate planning
tools you can use to transfer your business. Selecting the right one will depend
on whether you plan to retire from the business or keep it until you die.
Perhaps you have children or other family members who wish to continue the business
after your death. Obviously, you'll want to transfer your business to your successors
at its full value. However, with potential income, gift, and estate taxes, it takes
careful planning to prevent some (or all) of the business assets from being sold
to pay them, perhaps leaving little for your beneficiaries. Therefore, business
succession planning must include ways not only to ensure the continuity of your
business, but also to do so with the smallest possible tax consequences.
Some of the more common strategies for minimizing taxes are explained briefly in
the following sections. Remember, none are without drawbacks. You'll want to consult
a tax professional as well as your estate planning attorney to explore all strategies.
You may get some relief under the Internal Revenue Code
If you are prepared to begin transferring some of your business interest to your
beneficiaries, a systematic gifting program can help accomplish this while minimizing federal gift and estate tax liability (and state transfer tax liability, if applicable) that might otherwise be incurred. This is done by utilizing
your ability to gift up to $17,000 (in 2023, $16,000 in 2022) per year per recipient without incurring transfer
tax. By transferring portions of your business in this manner, over time you may
manage to transfer a significant portion of your business free from transfer tax. Clearly,
the disadvantage of relying solely on this method of transferring your business
is the amount of time necessary to complete the transfer of your entire estate.
In addition, Section 6166 of the Internal Revenue Code allows any federal gift and estate tax incurred
because of the inclusion of a closely held business in your estate to be deferred
for 5 years (with interest-only payments for the first four years), and then paid in annual installments over a period
of up to 10 years (installment payments include both principal and interest). This allows your beneficiaries more time to raise sufficient
funds or obtain more favorable interest rates. The business must exceed 35 percent
of your gross estate and must meet other requirements to qualify.
Selling your business interest outright
When you sell your business interest to a family member or someone else, you receive
cash (or assets that you can convert to cash) which can be used to maintain your lifestyle
or pay transfer taxes. You choose when to sell — now, at your retirement, at your
death, or anytime in between. As long as the sale is for the full fair market value
(FMV) of the business, it is not subject to transfer taxes. But if the sale
occurs before your death, it may be subject to capital gains tax.
Transferring your business interest with a buy-sell agreement
A buy-sell agreement is a legal contract that prearranges the sale of your business
interest between you and a willing buyer.
A buy-sell agreement lets you keep control of your interest until the occurrence
of an event that the agreement specifies, such as your retirement, disability, or
death. Other events like divorce can also be included as triggering events under
a buy-sell agreement. When the triggering event occurs, the buyer is obligated to
buy your interest from you or your estate at the FMV. The buyer can be a person,
a group (such as co-owners), or the business itself. Price and sale terms are prearranged,
which eliminates the need for a fire sale if you become ill or when you die.
Remember, you are bound under a buy-sell agreement: You can't sell or give your
business to anyone except the buyer named in the agreement without the buyer's consent.
This could restrict your ability to reduce the size of your estate through lifetime
gifts of your business interest, unless you carefully coordinate your estate planning
goals with the terms of your buy-sell agreement.
Grantor retained annuity trusts or grantor retained unitrusts
A more sophisticated business succession tool is a grantor retained annuity trust
(GRAT) or a grantor retained unitrust (GRUT). GRAT/GRUTs are irrevocable trusts
to which you transfer appreciating assets while retaining an annuity or unitrust
payment for a set period of time. In general, an annuity means you receive fixed
periodic payments, while a unitrust means you receive payments of a fixed percentage
of trust assets (revalued annually). At the end of the annuity or unitrust payment period, the assets in the trust pass to the other trust beneficiaries (the remainder
beneficiaries). The value of the retained annuity or unitrust interest is subtracted
from the value of the property transferred to the trust (i.e., a share of the business),
so if you live beyond the specified payment period, the business may be ultimately
transferred to the next generation at a reduced value for transfer tax
A private annuity is the sale of property in exchange for a promise to
make payments to you for the rest of your life. Here, you transfer complete ownership
of the business to family members or another party (the buyer).
The buyer in turn makes a promise to make periodic payments to you for
the rest of your life (a single life annuity) or for your life and the life of a
second person (a joint and survivor annuity). A joint and survivor annuity provides
payments until the death of the last survivor; that is, payments continue as long
as either the husband or wife is still alive. Again, because a private annuity is
a sale and not a gift, it allows you to remove assets from your estate without incurring
Until very recently, exchanging property for an unsecured private annuity allowed
you to spread out any gain realized, deferring capital gains tax. Proposed regulations
have effectively eliminated this benefit for most exchanges, however. If you're
considering a private annuity, be sure to talk to a tax professional.
Self-canceling installment notes
A self-canceling installment note (SCIN) allows you to transfer the business to
the buyer in exchange for a promissory note. The buyer must make a series of payments
to you under that note. A provision in the note states that at your death, the remaining
payments will be canceled. SCINs provide for a lifetime income stream and avoidance
of transfer taxes similar to private annuities. Unlike private annuities,
SCINs give you a security interest in the transferred business.
Family limited partnerships
A family limited partnership can also assist in transferring your business interest
to family members. First, you establish a partnership with both general and limited
partnership interests. Then, you transfer the business to this partnership. You
retain the general partnership interest for yourself, allowing you to maintain control
over the day-to-day operation of the business. Over time, you gift the limited partnership
interest to family members. The value of the gifts may be eligible for valuation
discounts as a minority interest and for lack of marketability. If so, you may successfully
transfer much of your business to your heirs at significant transfer tax savings.