There is a moment that successful private business owners rarely recognize as the most valuable window of opportunity they will ever have. It is the quiet stretch when the interested buyers have started calling; their intent it real, but nothing is yet in writing.
If that describes your company, the clock is already running.
The problem a successful sale creates
For many founders, a business liquidity event pushes the proceeds into a federal estate and gift tax exposure - currently anything above $15 million per person and $30 million for a married couple. Every dollar above that limit faces a 40% federal estate tax at death. (in addition to the income and/or capital gains tax on the sale.)
Be sure to apply the proper math: A 50 year-old married business owner who nets $20 million from the sale may look at the $30 million exemption and conclude he has no estate tax problem. Compounding says otherwise. At a net growth rate of just 5%, $20 million becomes approximately $86.4 million in 30 years. The taxable excess over today’s $30 million exemption is then about $56.4 million - and the 40% federal estate tax claims roughly $22.6 million; more than the entire original sale proceeds.
The advance planning that prevents this is well established and fully available under Florida law, but it works dramatically better, and in some cases only works at all, before the bona fide offer exists.
Why “before the bona-fide offer” is everything
Two forces cut against the owner who waits.
1. The first is valuation: Today, the business value is a manageable “seed”. Transfer it now and you move tomorrow's full “tree” out of your taxable estate at today's lower appraised value. Once a formal offer is made, the offer becomes a known fact any appraiser must consider, and the opportunity is dramatically diminished.
2. The second is the anticipatory assignment of income doctrine: When a sale has become a practical certainty, the IRS can disregard last-minute planning maneuvers and tax the seller as though they never occurred. Transfers made while interest is still general and non-binding stand on solid ground, but a signed document is the strongest evidence that certainty existed. The safe course: plan first.
The sequence, in three steps
Step one: value the business today. A qualified independent appraisal before any offer arrives.
Step two: create the irrevocable trust. A highly specialized trust with an independent trustee, plus an independent individual who will hold a “special power of appointment”.
Step three: make the gift. Business interests go into the trust before the sale.
The Irrevocable Trust:
This is a sophisticated trust that comes in different flavors.
Before any bona-fide offer has been received:
a) The business owner creates this trust for the benefit of his spouse, children and future descendants as beneficiaries.
b) The owner, not the trust, pays the income tax on the business sale. Therefore, the trust continues compounding unburdened.
c) The owner then puts his business ownership interest (not its operations, just ownership) into this trust.
d) When the business sells, the sale proceeds remain in the trust; not in his own taxable estate.
e) The Independent Trustee distributes funds over time as needed for the spouse and children. The remaining sale proceeds - and all future growth - remain in the trust.
“Flavors”
There are mechanisms in irrevocable trusts that the owner can choose from to return cash flow to the owner and his family without creating an estate tax issue; depending upon the “flavor” of trust:
1) SLAT (Spousal Lifetime Access Trust) For the duration of their married lifetimes, the Independent Trustee distributes funds to them as needed. The remaining sale proceeds - and all future growth - remain invested in the trust; all of which is sheltered from estate taxes and generally protected from creditors, civil lawsuits and divorcing spouses – for up to 1000 years. (Commonly each spouse creates a SLAT for the other spouse to use both exemptions).
2) INSTALLMENT SALE Before any offer exists, the owner makes an initial gift of about 10% to the trust, then sells the rest of his business interest to the trust at appraised value in exchange for a promissory note. The sale to his own trust triggers no tax event, the note pays him a predictable income stream, and all future growth stays in the trust. (The note’s unpaid balance stays in his estate.)
3) SPAT The trust can provide an income to spouse and children and contain a Special Power of Appointment which allows a Designated Powerholder to move assets into a new trust for the owner. The power is never designed to be needed, and its existence in someone else's hands is what lets an owner give with confidence.
Within Each Trust is A Dynasty Effect
a) A federal Generation-Skipping Transfer Tax exemption is priceless. Applying a GSTT exemption to your trust today can make the business sale proceeds - and all of it’s future growth passing from generation to generation – completely free of federal gift and estate tax for as long as the trust endures; up to 1,000 years under Florida law for trusts created today
b) This same trust generally protects multiple future generations - for up to 1000 years - against lawsuits, divorces, and their own federal estate taxes or probate.
The takeaway
If buyers are expressing interest and nothing is in writing, you are standing in the best planning window of your financial life.
Transferring the ownership title of your business into a specialized irrevocable trust - before a large sale offer is proffered - can shield the exemption-covered sale proceeds from a 40% estate tax, shelter its growth from that same devastating estate tax in future generations - and generally protect it from the creditors, lawsuits, and divorcing spouses of your descendants - for up to 1000 years.
Michael T. Koenig, CFP®, J.M., advises business owners and their families on wealth transfer and pre-sale planning. This article is educational commentary, not legal or tax advice. These strategies are fact-dependent and should be implemented with qualified estate planning counsel and a credentialed business appraiser before any written offer is entertained.