Leave A True Legacy Through Succession Planning

You have been successful. Careful succession planning should precede the transfer or sale of a family business. Whether you strategize carefully or not at all, the tax effects of your decisions will determine how much or how little your heirs will ultimately receive.

You have poured heart, soul and resources into your family business for years. You've built a strong company. Now, even though the hard work continues, you are also able to enjoy the fruits of your labors. You have been successful.

Now you are wondering how best to pass the benefits of your success along to your children. Should you transfer ownership of the company to them? Should you sell the business and structure your estate so that they receive part of the proceeds? Careful succession planning should precede the transfer or sale of a family business. Whether you strategize carefully or not at all, the tax effects of your decisions will determine how much or how little your heirs will ultimately receive.

This is an area in which thinking "outside the box" may help you achieve tax benefits and reach other deep personal goals. By working in conjunction with a community foundation such as The Greater Cincinnati Foundation ("GCF"), you may be able to transfer or sell your business, minimize the tax bite and create a permanent charitable legacy to benefit the community in which you achieved success.

Transferring The Family Business To Children

Take the hypothetical example of Mary Smith, a widowed small business owner in Greater Cincinnati who is ready to begin transferring her $10 million company to her children's control. No buy-sell agreement restricts her ability to transfer the company stock, but if she gives her children shares outright, the transfer will constitute a taxable event. Luckily, she has other options.

Ms. Smith could instead choose to give blocks of the stock to The Greater Cincinnati Foundation—in one lump sum or over time, at her discretion—to establish a "supporting organization" in her family's name. A supporting organization, such as a private foundation, is a legal entity that receives and invests assets for the benefit of public charities. However, unlike a private foundation, a supporting organization is itself a public charity by virtue of its relationship to GCF, so it is entitled to more favorable tax treatment. If she donates stock to a supporting organization, Ms. Smith can take an income tax deduction of up to 30 percent of her annual adjusted gross income, based on the then-current appraised market value of her gift.

The IRS will allow her a 5-year carry forward period in which to use the deduction. (If she cannot use the entire deduction in 6 years, she may consider giving the stock to GCF over time.) In addition to the income tax benefit, she avoids capital gains tax.

Once the company is transferred to the supporting organization, how will the Smith heirs obtain ownership? Ms. Smith can capitalize on the $10,000 annual exclusion amount to make yearly cash gifts to each of her children. In turn, they can use that income (and any other assets at their disposal) to purchase shares of the company stock from the supporting organization over time. The cash that they use to buy the stock will be invested in the Smith Family supporting organization at The Greater Cincinnati Foundation, and the assets of that entity will further Ms. Smith's philanthropic goals.

But wait—the scenario gets even better. With the income tax savings she achieves through her charitable stock gifts, Ms. Smith may decide to purchase a life insurance policy on her own life, to be owned by a wealth-replacement trust. If properly arranged, the proceeds of the life insurance policy can pass outside her taxable estate to her children at her death. Her children can use this cash to buy any remaining company stock from the supporting organization and to operate the family business in future years.

Selling The Family Business To A Disinterested Party

Shareholders of a business facing a sale or buyout are presented with opportunities for charitable giving similar to those described above. By contributing all or a portion of the closely held stock to a supporting organization at The Greater Cincinnati Foundation before a plan to sell has been put in motion, or before the date of the buyout, a shareholder may be able to dispose of his or her stock without incurring capital gains tax and also receive a charitable deduction for the full appraised value of the shares. In order for this strategy to succeed, it is important for the business owner to complete the stock transfer before the sale is final. Proceeds from the transfer would be received into the supporting organization, to be used exclusively for charitable purposes. The business owner may retain the right to name a minority of the directors of the supporting organization and can therefore position himself or herself to be directly involved in the entity's charitable grant-making decisions.

The goals of succession planning vary with the priorities of the business owner. With careful forethought, the owner of a family business can structure a transfer to maximize the legacy left to children and to the local community.

Reprinted with permission from The Family Business Report sponsored by the Goering Center at the University of Cincinnati College of Business Administration.