Introduction.
Every year, many of our clients decide to sell their businesses. When we serve as both estate planning counsel and corporate counsel, we are among the first to learn of the sale. We are then able to provide our clients integrated and cost-effective advice on all aspects of the sale.
Naturally, some of our estate planning clients engage separate corporate counsel to help sell their businesses. Unfortunately, in these cases, we may not learn of the sale until the client inadvertently remarks during a subsequent estate planning strategy session, "Oh, I sold the business last year. Didn’t I tell you?" By then, it’s too late. A major estate planning opportunity has been lost forever.
The bottom line is, the sale of your business may be the single most valuable estate planning opportunity you will ever have. In fact, if you are even considering the sale of your business, you should contact us immediately. Together with your other advisors, we will help you formulate an appropriate strategy for integrating your estate planning with the sale of your business before it is too late.
Discounting.
The most effective estate planning maximizes the amount of wealth you can transfer to your heirs without the imposition of gift or estate taxes by carefully creating and using valuation discounts. With appropriate discounts, you can make gifts of assets with a "real world" value which is much greater than their discounted value for gift and estate tax purposes. In other words, as illustrated below, you might be able to give away $3 of value but be treated by the IRS as if you only gave away $1 of value.
When engaging in estate planning with business assets, you can usually take advantage of two important types of valuation discounts. The first discount would result from your transfer of a minority interest in the business and typically ranges from 20% to 35%. A minority interest is discounted because its owner may have little control over the management of the business and, further, would have great difficulty finding a buyer for that interest. The second discount would result from your transfer of that minority interest to another estate planning vehicle, such as a family limited partnership or a grantor retained annuity trust. This second discount typically ranges from 20% to 90%, depending upon which estate planning vehicle is ultimately selected.
However, if you are planning to sell your business, you may be able to do even better. After all, you may be able to sell your business for more than its pre-sale appraised value. This would be especially true if your business is more valuable to your competitors than to you, which is often the case. In other words, the appraised value of your business in 1998 might be $4 million, but you might be able to sell your business to a competitor in 1999 for $6 million.
By engaging in estate planning in 1998, well in advance of the 1999 sale, you could take advantage of this difference in value. By engaging in estate planning after the sale, you would simply be leaving this valuable opportunity on the table, lost forever.
Example.
The following example illustrates how you could maximize your transfer of wealth to your heirs by creating discounts and making gifts to your heirs before the sale of your business.
Assume that the appraised value of your business (organized as a corporation) is $4 million before the sale. You could take advantage of the first type of discount by transferring a minority interest, say 40% of your company stock, to a newly-formed family limited partnership. Although this stock would have a "real world" value of $1.6 million, following an appropriate discount (35% in this example), this stock would have a "discounted" value of only $1.04 million.
You could obtain the second type of discount by making a gift of a minority interest in the newly-formed family limited partnership, say a 40% limited partnership interest, to your heirs. Following the application of this second type of discount (25% in this example), this limited partnership interest would have a "discounted" value of only $312,000 (75% of 40% of $1.04 million). Consequently, you could gift assets with a "real world" value of $640,000 (40% of 40% of $4 million) which is much greater than the "discounted" value of only $312,000. The difference would forever escape gift and estate taxes.
However, if you implement this program before you sell your business, your heirs could receive more "real world" dollars without increasing the "gift tax value" of the gift. For example, if you were able to sell your business for $6 million the next year, your heirs would receive $960,000 (i.e., 40% of the partnership’s sales proceeds). Yet, the gift tax value of this interest remains the same, only $312,000. In contrast, if you were to wait until after the sale to make a similar gift, the gift tax value would be at least $468,000, which is fifty percent higher than before the sale.
Simply by engaging in estate planning before the sale, you could transfer much more wealth to your heirs than if you waited until after the sale. Shouldn’t you take advantage of this opportunity?
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