You read this title correctly. With the right planning, delaying the transfer of ownership of your business could make sense. However this doesn’t mean you delay your succession planning.
Consider this scenario:
- You are the working owner of a music store and you own the building
- Your child or valued employee is the manager
- You have a simple “I love you” will (following your death all the stock of the company goes to your spouse)
- You have been depreciating the value of your building for 15 years, and as a consequence the IRS is demanding a “recapture” tax the moment you accept a note from your child
- You are concerned with the double taxation which occurs when you sell your shares to your child or key employee, and then are paid back with after tax dollars
Here’s an idea you may want to consider; it’s called a one-way buy-sell arrangement.
Unlike a typical cross-purchase buy-sell arrangement in which two or more business owners own life insurance policies on each other, a one-way buy-sell arrangement only requires the purchase of one life insurance policy on the owner of the business. This arrangement can be funded with a permanent life insurance policy to provide the flexibility needed to accommodate changing needs over the life span of the business.
This is how it works:
1-A buy-sell agreement is first established between the owner and the child manager or key manager.
2- The business agrees to pay the tax-deductible premiums for a life insurance policy on owner.
3-Child manager or key manager owns the policy and is the beneficiary.
4-The cost to child/key manager is the income tax due on the premiums paid by the business as a bonus. The bonus payments may be tax-deductible to the corporation when they are paid, but the payment will also be taxable to the child or key employee. The company may also choose to make a double bonus, which is equivalent to the premiums due plus the income tax due on the bonus.
5- At owner’s death, child or key manager receives the death benefit free of income tax.
6- As directed by the buy-sell agreement, child or key manager uses the life insurance proceeds to purchase 100% of business shares and the building from the owner’s estate (often the spouse of the owner).
7-Since policies are owned by child or key manager, death benefit will not be included in the owner’s estate.
8- Structuring the transaction in this manner not only maximizes income-tax efficiency but also retains all of owners’ currently available gifting capacity.
9-The successor/child or employee should receive a full basis step-up for the purchase of the business interest.
10-Given enough time, the life insurance plan may also be designed to pay the owner upon retirement or disability.
Keep in mind that just because there will be a formal delay to selling the business doesn’t mean you’re getting a free pass to delay succession management. Mentoring, leadership development and preparing the child or key manager for future ownership is vitally important. To do it right still takes time.
You will also need to establish the value of the business in order to ascertain the value of the life insurance policy that will be used to fund the buyout.
For situations where there are multiple business owners, you will have several buy-sell options to choose from such as cross-purchase, entity redemption, or cross-endorsement arrangements.
You have worked hard to make your business a success. Don’t give away the store because you did not have the right succession plan in place. Get advice from professionals who take time to understand your business. Explore the benefits of our MusicBiz Groups by attending our webinar. Remember, succession success requires an inter-disciplinary team. Often there are many techniques which can be used. Don’t delay, ask us for ideas.
Please note: This content is for educational purposes only. MoneyCapsules does not offer Legal or tax advice. Please seek advice from your own advisors.
This post was previously posted on April 19, 2016