Retirement, Death, and Taxes: A Guide to Retirement and Estate Planning for Business Owners
The concept of retirement is a part of almost every American dream. We talk about retiring and enjoying life after a fulfilling career of hard work. While all of these retirement dreams need proper planning to occur, there also needs to be planning for the corporate ownership as retirement becomes imminent.
One of the biggest questions a business owner needs to answer is, “what will happen to the business when I retire, or God forbid if I should die prior to retirement?” Forget for a moment the formidable concerns a business owner may have in regards to being able to afford retirement, but what will they do with the business once they do retire? Many owners have not given much consideration of the tax consequences that will occur if no planning is done.
When there is only one owner a common concept is to sell the business to achieve retirement. However, business owners are usually unaware of how the proceeds from the sale will be taxed. The government views the income you receive on the sale of your business in one of two ways: Basically, it is seen as either personal income or capital gains. Personal income is taxed higher than capital gains, in some instances significantly higher, giving capital gains a decidedly greater tax advantage. When selling your company, the structure of the company and the nature of what’s being sold determine whether the income is personal or capital gains.
As the seller, you can bargain for terms that give you a better tax advantage. If you accept payments, you can select proceeds to be taxed as capital gains at the end of the transaction. Selling the stock of a corporation means that the buyer accepts all the aspects of the company, including any of the liabilities. The liabilities will include any outstanding debts as well as any possible litigation against the company that existed prior to the transfer in ownership. Because of this, buyers are more apt to want to buy the assets rather than the stocks.
When there is more than one owner, selling the entire business is not necessarily an option. In such instances a buy-sell agreement can greatly alleviate potential problems. The buy-sell agreement is protection given to the owners on who can buy a departing partner’s or shareholder’s share of the business (this may include outsiders or be limited to other partners/shareholders); what events will trigger a buyout, and; (the most common events that trigger a buyout are: death, disability, retirement, or an owner leaving the company) what price will be paid for a partner’s or shareholder’s interest in the partnership.
Without proper planning, an owner wanting to continue the business, as well as the owner wanting to retire and rid their ownership, will have hurdles that will be difficult to overcome. In instances were there are multiple owners and a buy-sell agreement is not in place, the deceased owner’s estate will obtain their interest in the business. This will result in the heirs or spouse of the deceased owning part of the business. This is often problematic as the existing owners may not want to work with their deceased partner’s heirs and the heirs may have no interest in the business. A buy-sell agreement will get rid of such problems.
It should also be noted that when selling a business or in contemplation of death there should be a certified business valuation. The valuation is important to determine an accurate value of the business so that when an owner wants out he will be compensated appropriately and that a fair value has been given for the percentage of ownership for the exiting partner. In addition, it will put a fair market value on the company for estate tax purposes. A transfer in ownership is a taxable transaction and a valuation combined with a Transactional Tax Plan can help lower the overall tax from the sale of the business.
An important consideration that a retiring business owner should have is the estate tax that their families’ will be subjected to on all assets that they own. The value of the business itself is a critical piece of the estate and will be subject to estate tax. If the decedent was the sole owner of a small business, then they are responsible for the entire business as a part of their estate upon death. The value of the business is added into the estate and settled as part of the regular estate taxes. Similarly, if the company has multiple owners, the percentage owned by the decedent will pass to his estate and will be settled as part of the regular estate taxes (assuming no buy-sell is in place). In a case where there is not a certified business valuation performed by a objective third-party, the IRS will determine the value of the company and the burden will be on the estate to disprove that value if it is thought that the value given by the IRS is too high. This burden may be very difficult, not to mention expensive, to overcome.
Appropriate estate planning can help alleviate taxes on the value of the business and it is important for the business owners to determine what their wishes are for that planning to occur effectively. Too many of business owners have never given much thought to estate planning in general, let alone the thought on the impact their business ownership will have on their estate.
Proper guidance in retirement and estate planning is necessary and STA can assist. With proper planning we can help minimize the financial pain and suffering that a family goes through when a family member dies and provide an array of recommendations to use the business to fund retirement. We can help ensure that whatever their wishes are, that they are adhered to in a tax advantageous manner.
