Tax Secrets of the Wealthy: Succession planning

The right way to value your family business, while winning the tax game

Do you own all or part of a closely-held business? Like it or not, some day you’ll have to value that business. If you don’t, the IRS will.

Stuff happens — things like gifts or a sale of the family business to the kids, death (requiring valuation for estate tax purposes), or divorce (where valuation becomes an expensive legal battle). Or, how about buying a business, or selling your business to an individual not related to your family. The wrong valuation can rob you and your family of hard-earned dollars. It can even cause your business to be sold to pay taxes.

Let’s say you want to value your business because the time has come to transfer your business to your children. Why? You want to slow down, the kids are ready (and, of course, want to run the show), and the estate tax monster will enjoy a big payday if you get hit by a bus. All good reasons. Yet, you are torn. Why? You don’t want to give up control. Does all or any part of this paragraph apply to you or someone in your family?

If so, keep reading. You are about to be delighted at how easy it is to transfer your business to the next generation, save a ton of taxes, and still stay in control for as long as you live. About 90 percent of the calls we get (either from the business owner, one of the business owner’s children, or their CPA or lawyer) from readers of this column involve valuing the business for a sale/gift or other transfer to the younger generation. What you are about to read is routine. We’ve done it hundreds of times. It always works. It’s easy to do. And best of all, the IRS is never a problem.

Let’s run through an outline of the five-step process of the best way to transfer your business to your children. We call it the “Tax-free transfer strategy.” Assume Joe owns 100 percent (it can be any percentage) of Success Co.

Step one: Recapitalize Success Co. A “recapitalization” is a fancy name for turning your old voting common stock (Joe owned all 200 shares of Success Co.) into voting (say, 100 shares) and non-voting stock (say, 10,000 shares).

Step two: Have Success Co. valued. I have written eight books on business valuation and have given dozens of lectures and seminars on the subject. If you shoot for the right valuation (not high or low), competent business valuation experts always seem to come very close to the same valuation for a profitable business. Admittedly, nonprofitable businesses are a challenge to value. Joe’s business is profitable and was valued at 5.1 times pretax earnings. (Whether you operate as a C corporation, S corporation or other entity, does not change the value of the business). The appraiser’s report valued the non-voting stock of Success Co. at $5 million before discounts.

Step three: Take appropriate discounts. Joe is transferring only the 10,000 non-voting shares to his children. The tax law awards you three separate discounts: a discount for lack of marketability, a minority discount (since the non-voting stock has no vote, it automatically gets this discount), and the fact that a share of non-voting stock is worth less than a share of voting stock, wins you a third discount. Typically, the combined discounts amount to about 40 percent. The value of Success Co.’s non-voting stock is only $3 million for tax purposes ($5 million times 40 percent equals a $2 million discount).

Step four: Elect S corporation status if you are now a C corporation.

Step five: Transfer only the non-voting stock to the children, using an intentionally defective trust (IDT). An IDT does two great tricks. It transfers all of Success Co.’s non-voting stock to the children tax-free. This is one big deal, saving about $700,000 in taxes for each $1 million of the stock price (in this case, real dollar tax savings of $2.1 million). Because Joe keeps all 100 voting shares of Success Co., Joe retains absolute control for as long as he lives. It should be noted that there are many variations of the tax-free transfer strategy to accommodate the endless number of various family and business circumstances that come up in real-life business succession situations, and it’s always easy to adapt a perfect strategy for a family-owned business.

Irv Blackman is a certified public accountant who lives part-time on Marco Island and specializes in estate planning, business succession and asset protection. E-mail him at or call 417-9732. His Web site is

© 2009 All rights reserved. This material may not be published, broadcast, rewritten or redistributed.

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