If you own a family business, you are likely often preoccupied with the needs of your company at any given moment. Whether you’re checking on the status of a project outsourced to a vendor, contemplating how to increase the visibility of your brand, or reviewing the books, the immediate needs of your company and those it serves are almost certainly among your most pressing concerns. This is understandable, especially given how much a business can change from day to day and how much what goes on at any given moment can affect it. Yet, it also remains important to carve out time to address future concerns that will only become consequential down the road.
Take, for example, the potential tax consequences associated with the succession process. At some point you will retire, pass away, or otherwise no longer be in a position to run your business, perhaps due to injury or advanced illness. Under these circumstances, control of the business will necessarily pass to the next generation or will be addressed in other ways. The business could be dissolved or sold to a third party, for example. At that time, both you or your estate—in addition to the business itself—will need to navigate a number of practical and financial concerns, including the tax consequences associated with the business succession process.
In this article, the knowledgeable CPAs at Ferguson Timar introduce the tax issues that affect family businesses during the process of succession. By proactively addressing these concerns and adopting a more forward-thinking approach, you can ensure your family’s business transitions as seamlessly as possible from one generation to the next.
Minimizing Tax Liability
Assuming you and your loved ones want the business to continue to operate within the family, you need to take certain steps to minimize the tax liabilities that can arise when ownership is transferred from you to whomever will run the company next. As the tax consequences of the business succession process are different when ownership transfers within a family, it’s important to understand how the decisions you make now could impact your loved ones and your business when your ownership transfers.
As is the case with minimizing personal tax liability each year when tax season rolls around, it is generally astute to employ a variety of strategies to minimize the tax consequences associated with family business succession. Potential tax issues that may arise include:
- Business income taxes
- Capital gains taxes
- Estate taxes
- Generation-skipping transfer taxes
- Gift taxes
Some strategies must be employed in advance, and some only go into effect once a transfer has been made. Seeking personalized guidance from our CPA team can help you better understand which strategies are the most effective for your unique needs and circumstances. We also provide guidance about when to take each step so you and your family can achieve maximum benefits from your efforts.
Gifting Strategies
Each year small business owners are empowered to take advantage of gift tax exclusions. At present, the maximum for this single-time tax exemption is $18,000 for an individual filer and $36,000 for married couples filing jointly. Until these limits expire at the end of 2025, they can be used to gift interest in a business that meets value exemption limits of $13.61 million for an individual or $27.22 million for a married couple. If you’re in a position to leverage these limits to your advantage this year and next, this can minimize a host of company tax consequences once you’re ready to transfer the business.
Giving Your Beneficiaries a Loan
You can also opt to loan your family members the money to purchase the business from you at the lowest interest rate allowed by law—the Applicable Federal Rate (AFR). To accomplish this, you can use a grantor trust. You assume the tax burden for the business’s earnings while minimizing the transfer tax burden overall, perhaps quite significantly.
Setting Up Trusts
Setting up an Intentionally Defective Grantor Trust (IDGT) allows future appreciation value to transfer from the estate of a business owner to that owner’s family members. It also minimizes transfer-related taxes, including generation-skipping transfer taxes, if the beneficiaries in question are at least two generations removed from the trust creator. If your succession strategy includes multigenerational beneficiaries, this may be an especially beneficial option.
Alternatively, crafting a Grantor Retained Annuity Trust (GRAT) minimizes tax consequences while allowing current business owners to continue to benefit from income generated by the transferred business. The ownership of the company transfers to an irrevocable trust. Once the value of the business and interest at the AFR have been paid out over a fixed number of years, beneficiaries receive the remaining value without incurring any transfer taxes. Your business must be valued at a certain level for this approach to be successful.
Ferguson Timar Provides Counsel to Achieve the Most Out of Your Business Accounting
These are only a few of the strategies that the skilled CPAs at Ferguson Timar can use to reduce the tax burdens associated with business succession. For personalized feedback designed to keep more of your hard-earned business income in your family’s pockets, connect with our team today by calling (714) 204-0100. We look forward to hearing from you.