Successful Succession

Don’t lose your LEG to the tax collector. Make sure you have a lifetime plan for keeping it in the family.


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If you own all or part of a closely held business, sooner or later, like it or not, you will have to wrestle with succession planning problems. And you undoubtedly will need help to solve such a business succession puzzle.

Most such owners who call me for help do not have an estate plan, or, if they do, the plan is out of date. Let me be clear: Your succession plan cannot be “done right” if it is not part of a comprehensive estate plan.

Most clients also are not aware that their most valuable asset is what I call “lifetime equity growth” or LEG: the ability to earn income of all types for the rest of their lives. The value of most of your assets will grow over time because of inflation or simple increases in intrinsic worth. Plain logic tells you that your LEG is crying for a lifetime tax plan.

Estate taxes are harmless until you (and your spouse, if you are married) die. According to data compiled by the Social Security Administration, an American male who currently is 65 years old can expect to live another 19 years or so, and a woman of the same age another 21 or so. Calculate your own life expectancy, and then figure out how many years your LEG will likely increase your taxable wealth and your potential estate tax liability. This will show you why you need a lifetime plan to keep your LEG in the family instead of losing it to the IRS.

The following example explains how we solved one business owner’s succession planning problems with three individual plans that, in the end, amounted to one comprehensive plan.

The Succession Plan
Sixty-two-year-old Joe owns 100 percent of Success Co., an S corporation. Joe and his wife Mary, 57, have three children, only one of whom, Sam, works in the business. Joe’s goals are clear: 1) avoid taxes on the transfer of Success Co. to Sam, 2) treat the other two children who do not work in the business fairly and 3) create an estate plan that gets all his wealth to his family without a hit from estate taxes after both he and Mary die.

To address Joe’s first goal of transferring Success Co. to Sam without incurring taxes, we employed an intentionally defective trust (IDT). A professional appraiser valued the company at $15 million, but because of discounts allowed by law, Joe was able to sell Success Co. to the IDT for its discounted value of $9 million. Joe retained control of the business by retaining 100 shares of voting stock, while 10,000 shares of non-voting stock went to the IDT. Using an IDT saves the buyer and seller combined about $200,000 for each $1 million of the sale price. With Success Co.’s sale price of $9 million, this meant a savings of $1.8 million in taxes for Joe and Sam.

Although Joe’s second goal was to treat his “non-business” kids fairly, in a manner equal to how Sam was treated, he wanted them to remain uninvolved in the business, unlike their brother. However, the business was worth $15 million (before discounts), and all of Joe’s other assets (two homes, a 401(k) plan, a stock portfolio and real estate) amounted to only about $6 million. How could he make sure each of his three children got an equal share of his estate if he was already passing on a $15 million portion of it to a single one of them?

Our solution was to make each of the three children beneficiaries of equal thirds of the IDT. The trustee has been instructed to keep the non-voting Success Co. stock in the IDT until both Joe and Mary have died, at which time a properly drawn buy/sell agreement will kick in. At that point, the IDT will distribute the stock to the two non-business kids, and it will immediately be bought by the company using proceeds from life insurance on Joe and Mary. (Note: If Joe dies before Mary, the voting stock will go to Sam so that he can continue to run Success Co.)

The Estate Plan
To address Joe’s third goal of getting all his wealth to his family tax-free after both he and Mary die, we simply updated their wills and trusts to make sure that all aspects of these documents dovetailed with the other plans.

The Lifetime Plan
The heart of any estate plan is always the lifetime plan. Yes, estate planning documents like wills and A/B trusts are essential, but they don’t actually “do” anything until you die, and then it’s too late to do anything about estate taxes. 

Life insurance should most definitely be part of your lifetime plan. To incorporate this into Joe and Mary’s, we created an irrevocable life insurance trust (ILIT), which purchased a large second-to-die policy on the two of them. Their lifetime plan also ultimately included other tax-saving strategies: a family limited partnership for their income real estate and stock portfolio; a qualified personal residence trust for their two residences; a 401(k) plan with a subtrust to help pay some of their insurance premiums; a new management company to provide special fringe benefits to Joe and Sam as allowed by the tax law; and an annual gifting program that enabled Joe and Mary to give money outright to their children and grandchildren in order to reduce their taxable estate.

These strategies allowed Joe to accomplish each of his goals and get a “leg up” in his comprehensive estate planning.