I've been blogging in the past few weeks about the "family business"--i.e., that small business set up by an entrepeneur, and nourished to fruition--and issues that any successful small business owner should consider when getting closer to retirement age.
First, I discussed the issue of whether the family members had the desire or even the ability to carry on the family business, because in my anecdotal experience, fewer than half of entrepeneurs have families who are both willing and able to carry on the family business.
But for this week, let's assume your family falls into that category. If a member of you family has both the desire--and the ability--to keep the family business running, what you should consider next? Based upon my experience with family businesses, I would suggest that you next consider whether you should sell your business to your family, or whether you should
your business to your family.
The average non-entrepeneur I'd hazard would be be a bit aghast at the idea of selling his business to his family. The average non-entrepeneur believes that his or her job should be to share his wealth with his children, to the extent possible. However, entrepeneurs--many of whom came by success with some difficulty--are more open to the idea. There are many non-legal reasons why perhaps you should consider the issue of sale versus gift (i.e., anything worked for is much sweeter, in an entrepeneur's mind), but I'm going to focus on legal and tax implications for considering this question. As always, there is no generally right or wrong answer--the issue needs to be carefully considered, with the help of both tax and legal counsel. Here are just three things to think about when considering this issue.
1. ESTATE PLANNING
. One thing to consider is the tax consequences of your conveyance to your children (both income and estate). Chances are, the actual "book" value of your company (i.e. the value of its hard assets) is much less than you'd actually accept for it if you sold it on the open market. Perhaps, if you own a golf course, your land is worth $1 million, and your equipment is worth another $1 million. However, if your golf course is wildly successful, you might not be willing to sell it for less than $6 million (this value added to the hard value is what is commonly referred to as "good will"). Sometimes, tax lawyers or accountants will advise a sale of the company to children in order to reduce estate taxes.
Using the above example, even if you aren't willing to part with your golf course for less than $6 million, suppose your tax advisor tells you that--since you've never received an offer for your company and it has a book value of $2 million--you could legitimately sell it for $2 million to your children. You have effectively--and legally--gifted $4 million to your children without having to pay estate taxes.
Again using the above example, had you gifted your children the golf course with a book value of $2 million, that would not, at this time, create an estate tax consequence, but if you died leaving them much more property, you might very well create an estate tax burden for them (the subject of estate taxes is too lengthy and complicated to go into at depth; if you have any questions, please contact me and I will refer you to an excellent tax attorney).
Therefore, arms-length sales are sometimes an effective means by which to reduce your estate tax burden before you die.
2. REDUCING INCOME TAXES
. Sometimes, a sale versus a gift can reduce the income taxes your family may pay on its property in the long run. This is especially important if you are considering, in the short term, a sale of the business to an outside investor. Using the golf course example, again, let's say that, when all the equipment and land were purchased, their book value was $300,000. If you were to sell the business right now for $6 million, you would pay taxes on your gain (Sales price of $6 million, minus original basis of $300,000 = taxes on $5.7 million). If, however, you could in good faith sell your family business to your family for its book value ($2 million, in my example), your family would pay taxes on the gain of $6 million minus $2 million, which would reduce its taxable basis. (Understand that I'm using simplistic examples: a tax advisor may tell you to hold your business until you die so that your children could get a "stepped up basis"--in this case, $6 million; so please understand there is no one formula that fits all).
3. SELLING YOUR BUSINESS TO FAMILY CAN PROVIDE YOU INCOME
. Let's say that you family is willing and able to run you business, and your tax advisor believes that an arms-length book-value transaction is the best idea for your business. There's another good reason to sell your business versus giving it away: it can provide a steady stream of income. First, an assumption: almost no sale of family businesses to another family member involves an actual cash purchase. Instead, they typically involve selller financing. In addition to providing you tax savings, selling to your family can provide you a steady stream of income in the form of seller financing payments back to you on a promissory note. This is often important anyway, but if I am representing the spouse of a deceased entrepeneur, often this is even more important. Selling to the children, and owner-financing the sale, can provide to the seller a steady stream of income during the seller's golden years, while at the same time giving his or her children tax benefits and a leg up in this world.
If you have any questions, please call my office and set up an appointment at 704-735-0483.
Labels: entrepeneurs, family business, seller financing