When I was still a young CPA/lawyer in the mid-1950s, I did my first consultation with a family business owner who had the it’s-time-to-transfer-my-business-to-the-kids itch. And one thing is certain. Over 50 years later, nothing has changed.
The two biggest transfer fears of the ‘50s are still going strong, a decade into the 21st century. What are they? Here’s a hint. The number two fear is taxes – estate taxes, that is. And the all-time number one transfer-to-the-kids fear? Control! Yes, and get this, almost all owners (19 out of 20, to be exact) are frozen with fear when it comes to passing control to their own flesh and blood; so much so that many go to the big business in the sky and force their surviving families to overpay their estate tax. Why? Well, they held control (more than 50 percent) of the company’s common stock right up to the day they died.
But relax! There are little known, yet easy, ways to beat both fears. We use them year in and year out, in consultation after consultation, to turn worried family business owners/dads into happy and fearless I-control-it-but-don’t-own-the-business owners/dads. Two simple tax tricks are all it takes.
Let’s start with an example of how easy it is to maintain control using trick number one. The owner (Joe) exchanges all of his stock (common) in the corporation for two types of common stock: voting common (say 100 shares) and nonvoting common (say 10,000 shares). This transaction – called a recapitalization – is tax-free and works for both C corporations (tax-paying) and S corporations. Joe is now in the perfect position to keep the 100 voting shares (and control) and transfer the 10,000 nonvoting shares (and get them out of his estate) to the kids.
And now, trick number two: the transfer. Joe sells (really transfers, using an “intentionally defective trust,” because it is tax-free) the nonvoting shares to his kids over a period of years. Joe can own as little as 1 percent of all the stock (100 shares of voting stock) and still retain 100 percent of the voting control. Just what he wanted – low value, high control. No fears. Perfect!
A little side note: An intentionally defective trust (IDT) allows you to sell/transfer your business to your kids in a totally tax-free transaction: tax savings of $480,000 for each of the $1 million value of your business. For example, if your business is worth $4 million, you’ll save $1,920,000 in taxes. Be smart. Look into an IDT.
One more hint: Generally, annual gifts of $26,000 ($13,000 for Dad and $13,000 for Mom) of stock are used to transfer the family business to the kids when the business is worth about $2 million or less. When the business is worth more than about $2 million, an IDT is your best choice. Both – the gift of stock or the IDT – are tax-free to you and your kids.
Once the control and transfer issues are out of the way, my experience shows that owners of family businesses immediately want to learn more about how to win the estate tax game. Then the tax planning really gets exciting, because we show you how to pass all of your wealth – intact – to your family, tax-free.
Want to learn more about how to transfer your business? Save estate taxes? Browse my Web site, taxsecretsofthewealthy.com. There’s a ton of tax-saving free stuff.
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 email@example.com or call 417-9732. His Web site is taxsecretsofthewealthy.com.