by Karen Murphy, MostChoice.com

Deciding on the most effective way to pass your business to the next generation should always include legal and tax planning that takes into account your goals as a business owner and your unique situation as a family.

You may decide to hand the business over when you retire, using money from the company to help fund your retirement, or you may decide to run the company until your death. Circumstances may even call for you to sell the business.

Whatever your situation may be, you have several options available to accomplish your task. The difficult part is deciding what will work best for your business and to get the ball rolling as soon as possible. The earlier you plan, the more prepared you will be when the time for succession arises.

Well-known tax and legal strategies for the transfer of your business include those that are designed to help pay for estate taxes and those that help to reduce these taxes.

Plan for Liquidity

The value of your transferred assets is subject to a federal tax. However, the unified tax credit allows you to transfer $675,000 worth of assets free of tax. Any property in excess of that amount is taxed at rates from 37 percent to 55 percent. Therefore, you need to start planning now to provide the liquidity your heirs will need to pay for these taxes.

Business owners will often use one of three strategies -- deferrals, redemptions and buy/sell agreements -- to provide the needed liquidity.

• Deferrals -- If your business is more than 35 percent of your adjusted gross estate, you may be able to pay estate taxes on the value of the business interest over a period of up to 14 years. This way, you can defer the lump sum payment of estate taxes. Remember, though, that you will be charged interest at a rate set by law during the time it takes to pay it off.
• Redemption --Your heirs can redeem the closely held stock of the corporation, allowing them to maintain control of the company while gaining much needed liquidity. However, the entire proceeds from such a redemption may be taxed. If the proceeds of the redemption are used to pay administrative and funeral expenses, and your business is more than 35 percent of the gross estate, those proceeds will be tax-free. In order to qualify, the company must have enough cash to redeem the stock.
• Buy/sell Agreements -- A buy/sell agreement is a contract between two parties that defines how an owner will sell a particular interest in the business and how a buyer will buy that interest under certain situations. When funded with life insurance, this arrangement can provide the purchaser with the liquidity to buy the business. Life insurance purchased for the business owner guarantees a specific payout to the beneficiary upon a triggering event such as the death of the owner. In addition, a buy/sell agreement can establish the value of the business interest for federal estate tax purposes and help ensure that heirs receive full value by guaranteeing the sale and the purchase price.

Plan to Minimize Taxes

By using various techniques like the ones mentioned below, you may be able to reduce estate taxes and possibly even eliminate them. Because of the extremely complicated nature of both the tax and legal aspects involved in succession planning, it may be difficult to determine whether any of these strategies will work for you without first talking to a professional who understands your situation.

• Gifts -- In addition to the unified tax credit of $675,000, business owners can gift up to $10,000 per year to their offspring tax free. These gifts do not count as part of the $675,000 unified tax credit. This can help you pass the monetary assets of the company to your child over the course of time.
• Minority Interest -- You can reduce the tax payment by giving your children a minority interest in the company. Once their minority interest rises above 50 percent, the IRS will not go back and tax the earlier, minority interest gifts. This method can reduce the tax payment by 30 to 50 percent.
• Private Annuities -- A private annuity allows you to sell your business interest to a family member in exchange for a lifetime income. You can sell your business interest either all at once or over time. In return, you receive a steady stream of payments beginning at a specified date in the future and lasting as long as you do. The value of your business is not included in your gross estate as long as the value of the annuity equals the value of the exchanged business interest. If you outlive your life expectancy, your children may end up paying more than the business is worth. If you die sooner, they may pay less than the business is worth. One drawback is that you retain no secured interest in the business. You can, however, retain a secured interest with a secured interest note (SCIN) from a family member.
• GRATS -- Grantor Retained Annuity Trusts (GRATS) allow you to retain an interest for a specific time period while still giving away your assets and minimizing gift and estate taxes. Under this plan, the business stock is placed in a trust for the benefit of your children for a specified number of years. You receive a fixed annuity income and, at the end of the term, the stock is distributed to the children and removed from the your taxable estate. In this manner, they accumulate interest without the estate taxes being affected. Should you die before the end of the term, the stock is taxed as part of your estate.
• Family Limited Partnership -- With a family limited partnership, you can transfer some or all of your business to your family members while you are alive. When you die, the portion of the business that has been transferred is no longer considered a part of your estate and is not subject to estate taxes.

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