Industrial Strength Succession Planning

Raise your hand if you are the owner of a successful family business and you want your kids to step into your shoes someday. First, let’s be specific about the word “kids.


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Raise your hand if you are the owner of a successful family business and you want your kids to step into your shoes someday. First, let’s be specific about the word “kids.” We mean only those kids who are now in the business and who will someday run the business. We believe that kids who are not in the business should not share ownership with the business kids. Of course, the non-business kids will receive other assets, usually of equal value to the amount (value of the business) received by the business kids.

Although the situation described in the above paragraph comes up often, we have rarely seen a solution to the “how to transfer the business to the business kids and treat the nonbusiness kids fairly” problem. The rest of this article will describe our step-by-step solution.

We have nicknamed the process “Industrial Strength Succession Planning” because when the transaction is properly done, it holds together and successfully survives the test of time. Interestingly, when there is a problem, it is never caused by the plan’s technical aspects (the tax law and legal documents). Rather, it’s those human beings with different agendas and opinions who make up normal American families. Rarely—very rarely—are problems caused by the immediate family. Who creates the friction? Typically it’s a brother-in-law or sister-in-law married to a nonbusiness child who owns a piece of the business.

Let’s take a look at a real-life example, where the roof—because of family squabbling—almost caved in on a highly successful family business (Success Co., owned by dad, Joe). Joe owned 52 percent of Success Co.’s stock and his four adult children owned 48 percent (12 percent each). Three of the kids (Sam, Sol and Sue) work full-time for Success Co. The fourth kid (Ray) is a successful professional and has no interest in the business.

Sue had a baby and told the family she would not return to work until her daughter went to college. The squabbling started with Joe and the remaining business kids, Sam and Sol, on one side and Sue, her husband (Roy) and Ray’s wife (Roz) on the other.

Although the successful business struggled in the early years, it had always been a source of pleasure for Joe and Mary. Lately, it had become a thorn in their sides. First, we pinned down their specific goals for the business and all of their children: (1) stop the business bickering; (2) treat the kids equally (after much discussion, “equally” was redefined to mean the business to the business kids and other assets of equal value to the non-business kids); and (3) transfer Success Co., in a tax-effective manner, to the business kids, but allow Joe to maintain control for as long as he lives.

My advice, really my insistence, was that only business kids own stock of Success Co. Here’s the plan we implemented:

  • Success Co. was recapitalized (100 shares of voting stock and 10,000 shares of nonvoting stock). Every one of the shareholders got their proportionate share (that is, Joe got 52 voting shares and 5,200 nonvoting shares).
  • Success Co. was professionally appraised with a specific fair market value (FMV) per voting share and nonvoting share.
  • Success Co. redeemed (bought) all of the shares—voting and non voting—owned by the non-business kids (Sue and Ray) for their fair market value. Note: At that point Joe owned 68 percent of Success Co., while Sam and Sol each owned 16 percent (rounded) of the stock.
  • We used an intentionally defective trust (IDT) to transfer—tax free—the nonvoting shares (5,200) to Sam and Sol (2,600 shares each). The IDT saved Joe and his two sons about $2.7 million in income and capital gains taxes. Because the nonvoting shares, which contained about 99 percent of the FMV of Success Co., were no longer owned by Joe, the shares were out of his estate for estate tax purposes. Sam and Sol will receive the voting shares (half each) when Joe goes to the big business in the sky.

As readers of this column know, solving just a portion of a client’s estate tax problem is not our style. Always, but always, the comprehensive plan includes a complete lifetime plan (here, the succession plan was a part of the lifetime plan) and a complete estate plan that dovetails with the life plan. The overall plan for Joe and Mary is built around two basic concepts: (1) the ability to maintain their lifestyle for as long as they live; and (2) an estate plan that will pass all of their wealth—every dime of it—to their kids, instead of losing it to the IRS.