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How to Reduce Tax Impacts While Succession Planning

A focus on current tax laws and flexible planning can help business owners build a succession plan that reduces tax impacts.

This can mean everything for the retiree, his family and other stakeholders who want to avoid paying a large percent of the company’s assets to Uncle Sam.

Succession planning is a long-term strategic plan that paves the way for a smooth transition of management and ownership while considering the needs of the business and its owners.

When a business transfers to new owners, taxes can have a significant impact on the after-tax value of the business and its successors. The goal is to preserve wealth for both.

The dynamic nature of tax laws can make long-range planning difficult. Tax laws tend to change over time and there are other variables to consider too, such as the needs of the business, retirement goals and the structure of the company, which also affects business and personal taxation.

Skilled financial advisors, accountants, lawyers and investment bankers can help business owners create flexibility in their succession plan to accommodate changing tax laws and other circumstances. Due to tax exposure, personal estate planning and succession planning should go hand in hand.

One option that’s growing in popularity is the Family Limited Partnership (FLP). This partnership, which involves family members pooling money to run a business, can offer estate and gift tax advantages for passing wealth down to generations.

Every year, individuals can gift FLP interests tax-free to other individuals up to the annual gift tax exclusion. This year, (2019) the gift exclusion is $15,000 for individuals and effectively doubled to $30,000 for married couples.

Here are some other options to reduce taxes during a business transition:

  • Set up a holding company or family trust to take advantage of tax deferrals and savings, income splitting opportunities and protecting assets from creditors.
  • Create a spousal trust to protect a privately-owned business. Shares of the business can be put into a spousal trust so taxes aren’t immediately payable if one of them passes away.
  • Use life insurance to pay capital gains tax when there’s a forced succession due to death or incapacitation. Insurance premiums often cost less than the capital gains tax owed when a business owner dies.
  • Use your lifetime capital gains tax exemption on qualifying small business shares. Adjusted annually for inflation, the 2019 exemption is set at $866,912.
  • Transfer company assets over time to spread the tax bill out into smaller, more manageable chunks.
  • Gift or sell shares of the company to a successor who is a family member. The successor will not be required to pay taxes on it, but the owner will be responsible for capital gains tax on the fair market value at the time the gift was made.

Tax saving measures like these can maximize the company’s after-tax value, ensuring the business owner’s hard work pays off in their retirement while also protecting family members and business partners.