business succession planning - raymond james financial · business succession planning january 10,...

Nicholson Financial Services, Inc.David S. NicholsonFinancial Advisor89 Access RoadSte. CNorwood, MA 02062781-255-1101866-668-1101david@nicholsonfs.comwww.nicholsonfs.com

Family Business SuccessionPlanning

June 15, 2020

Transferring Your Family BusinessAs a business owner, you're going to have todecide when will be the right time to step outof the family business and how you'll do it.There are many estate planning tools you canuse to transfer your business. Selecting theright one will depend on whether you plan toretire from the business or keep it until youdie.

Perhaps you have children or other familymembers who wish to continue the businessafter your death. Obviously, you'll want totransfer your business to your successors atits full value. However, with potential income,gift, and estate taxes, it takes careful planningto prevent some (or all) of the business assetsfrom being sold to pay them, perhaps leavinglittle for your beneficiaries. Therefore,business succession planning must includeways not only to ensure the continuity of yourbusiness, but also to do so with the smallestpossible tax consequences.

Some of the more common strategies forminimizing taxes are explained briefly in thefollowing sections. Remember, none arewithout drawbacks. You'll want to consult a taxprofessional as well as your estate planningattorney to explore all strategies.

You may get some relief underthe Internal Revenue Code

If you are prepared to begin transferring someof your business interest to your beneficiaries,a systematic gifting program can helpaccomplish this while minimizing federal giftand estate tax liability (and state transfer taxliability, if applicable) that might otherwise beincurred. This is done by utilizing your abilityto gift up to $15,000 (in 2019 and 2020) peryear per recipient without incurring transfertax. By transferring portions of your businessin this manner, over time you may manage totransfer a significant portion of your businessfree from transfer tax. Clearly, thedisadvantage of relying solely on this methodof transferring your business is the amount oftime necessary to complete the transfer ofyour entire estate.

In addition, Section 6166 of the InternalRevenue Code allows any federal gift andestate tax incurred because of the inclusion ofa closely held business in your estate to bedeferred for 5 years (with interest-onlypayments for the first four years), and then

beneficiaries more time to raise sufficientfunds or obtain more favorable interest rates.The business must exceed 35 percent of yourgross estate and must meet otherrequirements to qualify.

Selling your business interestoutright

When you sell your business interest to afamily member or someone else, you receivecash (or assets that you can convert to cash)which can be used to maintain your lifestyle orpay transfer taxes. You choose when to sell —now, at your retirement, at your death, oranytime in between. As long as the sale is forthe full fair market value (FMV) of thebusiness, it is not subject to transfer taxes. Butif the sale occurs before your death, it may besubject to capital gains tax.

Transferring your businessinterest with a buy-sellagreement

A buy-sell agreement is a legal contract thatprearranges the sale of your business interestbetween you and a willing buyer.

A buy-sell agreement lets you keep control ofyour interest until the occurrence of an eventthat the agreement specifies, such as yourretirement, disability, or death. Other eventslike divorce can also be included as triggeringevents under a buy-sell agreement. When thetriggering event occurs, the buyer is obligatedto buy your interest from you or your estate atthe FMV. The buyer can be a person, a group(such as co-owners), or the business itself.Price and sale terms are prearranged, whicheliminates the need for a fire sale if youbecome ill or when you die.

Remember, you are bound under a buy-sellagreement: You can't sell or give yourbusiness to anyone except the buyer namedin the agreement without the buyer's consent.This could restrict your ability to reduce thesize of your estate through lifetime gifts ofyour business interest, unless you carefullycoordinate your estate planning goals with theterms of your buy-sell agreement.

paid in annual installments over a period of upto 10 years (installment payments include bothprincipal and interest). This allows your

There are many estateplanning tools you can useto transfer your business.Selecting the right one willdepend on whether you planto retire from the businessor keep it until you die.

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Grantor retained annuity trustsor grantor retained unitrusts

A more sophisticated business successiontool is a grantor retained annuity trust (GRAT)or a grantor retained unitrust (GRUT).GRAT/GRUTs are irrevocable trusts to whichyou transfer appreciating assets whileretaining an annuity or unitrust payment for aset period of time. In general, an annuitymeans you receive fixed periodic payments,while a unitrust means you receive paymentsof a fixed percentage of trust assets (revaluedannually). At the end of the annuity or unitrustpayment period, the assets in the trust pass tothe other trust beneficiaries (the remainderbeneficiaries). The value of the retainedannuity or unitrust interest is subtracted fromthe value of the property transferred to thetrust (i.e., a share of the business), so if youlive beyond the specified payment period, thebusiness may be ultimately transferred to thenext generation at a reduced value for transfertax purposes.

Private annuities

A private annuity is the sale of property inexchange for a promise to make payments toyou for the rest of your life. Here, you transfercomplete ownership of the business to familymembers or another party (the buyer). Thebuyer in turn makes a promise to makeperiodic payments to you for the rest of yourlife (a single life annuity) or for your life andthe life of a second person (a joint andsurvivor annuity). A joint and survivor annuityprovides payments until the death of the lastsurvivor; that is, payments continue as long aseither the husband or wife is still alive. Again,because a private annuity is a sale and not agift, it allows you to remove assets from yourestate without incurring transfer taxes.

Until very recently, exchanging property for anunsecured private annuity allowed you tospread out any gain realized, deferring capitalgains tax. Proposed regulations haveeffectively eliminated this benefit for mostexchanges, however. If you're considering aprivate annuity, be sure to talk to a taxprofessional.

Self-canceling installment notes

A self-canceling installment note (SCIN)allows you to transfer the business to thebuyer in exchange for a promissory note. Thebuyer must make a series of payments to youunder that note. A provision in the note statesthat at your death, the remaining paymentswill be canceled. SCINs provide for a lifetimeincome stream and avoidance of transfertaxes similar to private annuities. Unlikeprivate annuities, SCINs give you a securityinterest in the transferred business.

Family limited partnerships

A family limited partnership can also assist intransferring your business interest to familymembers. First, you establish a partnershipwith both general and limited partnershipinterests. Then, you transfer the business tothis partnership. You retain the generalpartnership interest for yourself, allowing youto maintain control over the day-to-dayoperation of the business. Over time, you giftthe limited partnership interest to familymembers. The value of the gifts may beeligible for valuation discounts as a minorityinterest and for lack of marketability. If so, youmay successfully transfer much of yourbusiness to your heirs at significant transfertax savings.

Grantor Retained Annuity Trust (GRAT)

Definition

A grantor retained annuity trust (GRAT) is anirrevocable trust into which a grantor makes aone-time transfer of property, and in which thegrantor retains the right to receive a fixedamount (an annuity) at least annually for aspecified term of years. At the end of theretained annuity period, the propertyremaining in the trust passes to the remainderbeneficiaries or remains in trust for theirbenefit.

A transfer of property to an irrevocable trust isa taxable gift. The value of the gift on which

federal gift and estate tax is imposed isgenerally its fair market value. However,because the grantor retains an interest in aGRAT, the value of the transfer is discounted;transfer tax is imposed only on the remainderinterest.

Note: Any transfer tax due may be shelteredby the grantor's lifetime gift and estate taxapplicable exclusion amount ($11,580,000 in2020, $11,400,000 in 2019).

This taxable value is calculated using aninterest rate provided by the IRS (known asthe discount rate or Section 7520 rate), which

A more sophisticatedbusiness succession tool isa grantor retained annuitytrust (GRAT) or grantorretained unitrust (GRUT).


is based on current interest rates and changesmonthly. This interest rate assumes the GRATproperty will earn a certain rate of returnduring the annuity period. Any actual returnthat exceeds the assumed return passes tothe remainder beneficiaries transfer tax free.Investment performance, therefore, is centralto this strategy.

For a GRAT to be successful:

• The grantor must outlive the term of years• The GRAT property must outperform the

Section 7520 rate• The GRAT document must be properly

drafted

Potential tax advantages of aGRAT include:

• Because of the retained interest, the valueof the transfer for federal gift and estate taxpurposes may be discounted

• Principal remaining in the GRAT at the endof the term of years is removed from thegrantor's gross estate for federal gift andestate tax purposes

• Interest (i.e., appreciation and/or earnings)remaining in the GRAT at the end of theterm of years passes to the remainderbeneficiaries federal gift and estate tax free

Key tradeoffs

• If the GRAT property underperforms theSection 7520 rate, no tax savings isachieved (and if the GRAT is depleted, noproperty is transferred to the remainderbeneficiaries)

• If the GRAT property underperforms theSection 7520 rate, gift taxes paid and/orany applicable exclusion amount used willbe wasted (though the amounts would beminimal)

• If the grantor does not outlive the term ofyears, any property remaining in the GRATis includable in the grantor's gross estatefor federal gift and estate tax purposes

• If the GRAT is unsuccessful, any costsincurred to create and maintain the GRATwill have been wasted

How is it implemented?

• Hire an experienced attorney to draft theGRAT document

• Have property that is transferred to GRATprofessionally appraised

• Transfer property to GRAT (i.e., retitleassets)

• File gift tax return(s)

Grantor Retained Unitrust (GRUT)

Definition

A grantor retained unitrust (GRUT) is anirrevocable trust into which a grantor makes aone-time transfer of property, and in which thegrantor retains the right to receive a variableamount (based on a fixed percentage of trustassets valued annually) at least annually for aspecified term of years. At the end of theretained unitrust period, the propertyremaining in the trust passes to the remainderbeneficiaries or remains in trust for theirbenefit.

A transfer of property to an irrevocable trust isa taxable gift. The value of the gift on whichfederal gift and estate tax is imposed isgenerally its fair market value. However,because the grantor retains an interest in aGRUT, the value of the transfer is discounted;transfer tax is imposed only on the remainderinterest.

Note: Any transfer tax due may be shelteredby the grantor's lifetime gift and estate tax

applicable exclusion amount ($11,580,000 in2020, $11,400,000 in 2019).

This taxable value is calculated based on thevalue of the property transferred to the GRUT,the unitrust payout rate, the term of the trust,and using an interest rate provided by the IRS(known as the discount rate or Section 7520rate), which is based on current interest ratesand changes monthly. However, unlike with aGRAT, the Section 7520 rate has little or noeffect on the value of the remainder interest ina GRUT.

A GRUT is the same type of trust as a grantorretained annuity trust (GRAT), except that witha GRAT, the grantor receives a fixed annuityamount rather than a variable unitrustpayment. Because of this, payments to thegrantor of a GRUT may increase or decreaseeach year depending on the value of the trustassets. And, because the unitrust paymentmust be recalculated each year, the cost toadminister a GRUT may be greater than witha GRAT. Another important differencebetween these two trusts is that unlike a

A grantor retained annuitytrust (GRAT) allows thevalue of the propertytransferred to the trust to bediscounted, while removingthe trust property from thegrantor's gross estate.

A grantor retained unitrustallows a discount for thevalue of the propertytransferred to the trust,while removing the propertyfrom the grantor's grossestate.


GRAT, a GRUT can't be zeroed out, andtherefore a taxable gift always results.

For a GRUT to be successful:

• The grantor must outlive the term of years• The GRUT document must be properly

drafted

Potential tax advantages of aGRUT include:

• Because of the retained interest, the valueof the transfer for federal gift and estate taxpurposes may be discounted

• Principal remaining in the GRUT at the endof the term of years is removed from thegrantor's gross estate for federal gift andestate tax purposes

• While not a tax advantage, if the value ofthe trust property increases, payments tothe grantor increase, possibly providingprotection against inflation

Key tradeoffs

• If the GRUT property performs poorly or isdepleted, there may be less thananticipated transferred to the remainderbeneficiaries and little or no tax savings

• If the grantor does not outlive the term ofyears, any property remaining in the GRUTis includable in the grantor's gross estatefor federal gift and estate tax purposes

• If the GRUT is unsuccessful, any costsincurred to create and maintain the GRUTwill be wasted

• If the value of the trust property decreases,payments to the grantor decrease, andmay not provide enough income

• If payments to the grantor increasebecause the value of the trust propertyincreases, the additional payments will beincluded in the grantor's gross estate forfederal estate tax purposes unlessconsumed or given away

How is it implemented?

• Hire an experienced attorney to draft theGRUT document

• Have property that is transferred to theGRUT professionally appraised

• Transfer property to GRUT (i.e., retitleassets)

• File gift tax return(s)

and gift taxes paid and/or any applicableexclusion amount used may be wasted

Planning for Succession of a Business InterestFlowchart


Business Succession Planning Alternatives

Lifetime gifts Bequest Lifetime sale Estate sale Buy-sellagreement

If you wantto:Sell yourbusinessinterest

Notappropriate

Notappropriate

You may beable to sellyour businessoutright — butthere is noguarantee

Your estatemay be able tosell yourbusinessoutright — butthere is noguarantee

Buy-sellagreementcan be used toprovide for thesale of yourbusiness

If you wantto:Givebusiness toyour children

You cancontrol thetiming and sizeof the gifts

You controlthe size of thegift throughyour will

Notappropriate

Notappropriate

Notappropriate

If you wantto:Sell businessto yourchildren

Can be usedin conjunctionwith sale

Notappropriate

You cancontrol timingof sale — butsale is notguaranteed

Your childcould buy fromyour estate —but sale is notguaranteed

Buy-sell canbe used toprovide foryour child'soption to buyyour interest

If you wantto:Minimizevalue of yourestate

Can be usedto reduce thevalue of yourestate andmaximize gifttax exclusion

Will notminimizevalue ofyour estate

You cancontrol timingof sale — butsale is notguaranteed

Value ofbusiness mustbe included inyour estate

Value ofbusiness mustbe included inyour estate,but thebuy-sell canhelp establishthat value


Business Succession Planning: Comparison ofAlternatives

FLP PrivateAnnuity

SCIN GRAT Lifetime Gifts

MinimizeFederal GiftTax

Yes1 Yes2 Yes Yes2 Maybe1

MinimizeFederalEstate Tax

Yes3 Yes4 Yes4 Yes4 Yes3

MinimizeFederalIncome Tax

Yes5 No No No Yes5

MinimizeFederalCapital GainsTax

Yes6 No Yes Yes6 Yes6

Income forTransferor

Yes Yes Yes Yes No

Control byDonor

Yes No No Yes No

CreditorProtection

Yes7 No No No Yes

Risk No Yes8 Yes8 No No

1. Value of gifted interest may be discounted, otherwise eligible for annual and lifetime gift taxexemptions

2. To the extent fair market value of business does not exceed present value of annuity3. Shifts future appreciation to children4. But not to the extent payments are received and increase the transferor's estate value5. Shifts income to children6. But note that donees do not receive a "step up" in basis on transferred assets7. Limited partners generally have no personal liability for partnership debts8. Transferor may not live long enough to receive full payment


Overview of Buy-Sell Agreement Forms

Agreement form Buyer Works well with Unsuitable for

Wait and see Business entity,co-owner, or both

Business with two ormore owners

Sole proprietor andsingle-shareholdercorporation

Trusteed crosspurchase

Co-ownerTransaction overseenby trustee

Business with two ormore ownersSimplifies plan whenlarge number ofowners


Entity purchase(stock redemption)

Business entity Business with two ormore owners

Most expensive type

Section 302 stockredemption*

Business entity Business with two ormore owners


Section 303 stockredemption*

Business entity Business with two ormore owners,especially familybusiness


Reverse Section 303stock redemption*

Business entity Business with two ormore owners,especially familybusiness

Sole proprietor andsingle- shareholdercorporation

Cross purchase(crisscross)agreement

Co-owner Business with two ormore owners

Sole proprietor andsingle-shareholdercorporationLarge number ofowners (getscomplicated with fouror more)

Option plan Business entity,co-owner, or anyeligible third partySale not guaranteed

Business with anynumber of owners,including soleproprietorship andsingle-shareholdercorporation

Any scenario whereguaranteed sale isneeded

One-way buy-sell Business entity,co-owner, or anyeligible third party

Business with anynumber of owners,including soleproprietorship andsingle-shareholdercorporation

Sole proprietor with nowilling buyer

*Section refers to an Internal Revenue Code Section.


Nicholson Financial Services,Inc.

David S. NicholsonFinancial Advisor89 Access Road

Ste. CNorwood, MA 02062

781-255-1101866-668-1101

[email protected]

June 15, 2020Prepared by Broadridge Investor Communication Solutions, Inc. Copyright 2020

Securities offered through Raymond James Financial Services, Inc. Member FINRA/SIPC. NicholsonFinancial Services, Inc. is not a registered broker/dealer, and is independent of Raymond James FinancialServices. Investment Advisory Services are offered through Raymond James Financial Services Advisors,Inc.

This information, developed by an independent third party, has been obtained from sources considered tobe reliable, but Raymond James Financial Services, Inc. does not guarantee that the foregoing material isaccurate or complete. This information is not a complete summary or statement of all available datanecessary for making an investment decision and does not constitute a recommendation. The informationcontained in this report does not purport to be a complete description of the securities, markets, ordevelopments referred to in this material. This information is not intended as a solicitation or an offer to buyor sell any security referred to herein. Investments mentioned may not be suitable for all investors. Thematerial is general in nature. Past performance may not be indicative of future results. Raymond JamesFinancial Services, Inc. does not provide advice on tax, legal or mortgage issues. These matters should bediscussed with the appropriate professional.

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