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— A VPA Perspective

Tax & Estate Planning for Founders Thinking about a Transaction

Summary
  • How planning tax & estate early will yield positive financial outcomes
  • Best practices for conducting tax & estate planning when preparing to sell your business

If you anticipate selling your business in the next 12-24 months, then now is the time to start thinking about tax & estate planning.

Planning your taxes and estate may seem like an activity reserved for when the transaction process is drawing to a close. However, if you wait until shortly before the deal is expected to close, you’ll lose the opportunity to take advantage of trust and estate options that enable various tax exemptions in the long run. These exemptions reduce your tax bill and make more of the funds available to you and your beneficiaries.

Though Vista Point is not a tax or wealth advisor, we represent founders preparing to go through transactions that result in a significant financial life event. Because we want our clients to get the best financial outcome possible, we always recommend our clients work with tax & wealth advisors (called wealth advisors for the remainder of this article).

Reasons to Work with a Wealth Advisor

Founders generally have the following objectives for their wealth when selling a business:

  • Provide for friends, family, and heirs
  • Donate to charity
  • Minimize income taxes

Wealth advisors can help founders reach those objectives.

Cash from the sale of assets is immediately taxable (typically at the long-term capital gains rate), so running an all-cash transaction isn’t the most favorable option. A wealth advisor can help you identify other financial vehicles that will provide tax advantages on what could be a life-changing amount of money from the sale of your business.

Below are a couple examples of tactics a wealth advisor could advise you on that you may not have considered.

Wealth Structuring Example 1: Gifting Stock to Beneficiaries

Instead of converting all your equity to cash, a wealth advisor can help you gift or sell your stock to your intended long-term beneficiaries.

Gifting equity has several tax advantages. If you gift equity to beneficiaries as restricted stock, those stocks are taxed at the time they are granted/vested. Because private stock is illiquid, the value of your stock will be discounted, creating tax-advantaged gains for the beneficiary as the stock appreciates with time. This structure results in taxes that are significantly lower than what you or your beneficiaries would pay in income tax if you had opted for an all-cash transaction.

Wealth Structuring Example 2: Contributing to a Charitable Remainder Trust

Charitable remainder trusts (CRTs) are another financial vehicle to create tax advantages, while also giving you an opportunity to donate to charity.

Upon the sale of your business, you can contribute to a CRT by transferring a portion of your appreciated stock to a trustee. The trustee will act as a shareholder when the company is sold, receiving their entitled/pro rata portion of the sale proceeds. The trustee then sells that stock and reinvests that money into various liquid securities to generate a risk-adjusted income for you or another beneficiary.

After generating income over your lifetime or a fixed number of years, the remainder of the trust is donated to your preferred charity or charities.

CRTs have several tax advantages:

  • As an irrevocable trust, the funds in a CRT are not considered part of your estate, so they will not be considered for estate taxes.
  • CRTs are not subject to capital gains taxes, which can be significant for appreciated assets.
  • Due to a future charitable donation, the grantor of a CRT (you), receives an immediate tax deduction.

These examples are just a couple of the approaches to manage private wealth in preparation for the sale of your business. You should consult with a private wealth professional to implement an effective, multi-faceted strategy for your situation. Below are different tactics a wealth advisor could help you with:

Provide for family and heirs (or beneficiaries), including charity

  • Outright Gifts
  • Family Limited Partnerships (FLP)
  • Grantor Retained Annuity Trusts (GRAT)
  • Defective Grantor Trusts (DGT)
  • Charitable Remainder Trusts (CRT)
  • Charitable Lead Trusts (CLT)
  • Generation Skipping Transfer Trusts (GST)

Provide for charity

  • Outright gifts
  • Charitable Remainder Trusts (CRT)
  • Charitable Lead Trusts (CLT)
  • Private Foundations, Donor Advised Funds and Supporting Organizations

Minimize income taxes

  • Charitable Remainder Trusts (CRT)
  • Charitable Lead Trust (CLT)
  • Exercise of Compensatory Stock Options
  • AMT

Best Practices for Planning Wealth as a Transaction Approaches

In general, when preparing your tax & estate for a liquidity event, you will want to:

  • Start planning as early as possible
  • Take discount opportunities as they arise
  • Integrate strategies

Start planning as early as possible

If you wait until a transaction is in process to plan your tax & estate, you’ve waited too long. Some of the financial vehicles require early action to yield their greatest benefit.

For example, in gifting situations, the value of stock is determined by the fair market value. If you wait until you’ve received several valuations from buyers, those valuations will hike fair market value and the price of your stock.

While an increase in stock price is good for your final outcome, your outcome will be even better if you had gifted that stock earlier because it would have been taxed at a discounted rate.

Take discount and exemption opportunities as they arise

Tax exemptions on gifts are limited: up to $15K/annum for individuals or $30K/annum for couples per recipient. These exemptions don’t accumulate, so if you don’t use them by December 31 of each year, they’re essentially wasted.

If you give gifts above this exempted amount, you will eat into your unified tax credit for gift taxes, which is capped at $11.58M over your lifetime (for 2020). Above that amount, you could pay up to 40% in gift taxes.

Note: Entities like Family Limited Partnership can help give structure to the transfer of assets to beneficiaries on a tax-advantaged basis.

Integrate strategies

Most likely you will combine strategies to meet multiple financial objectives for you and your beneficiaries. Which strategies you use will depend on the nature of the assets, how they are held, and how they are used.

You should consult professional advisors to review how they can help you reach your individual objectives given your priorities and constraints.

Start Planning Your Tax & Estate Now

Even if a liquidation event doesn’t seem to be close, 2020 is a good time to think through your tax & estate. Exemptions for gift, estate, and generation-skipping transfer taxes are at all time highs. In addition, asset valuations will be relatively low early in your company’s growth history. Planning now will help you yield the greatest benefit of a long-term tax & estate plan.

Modified on Jun 24, 2020