Succession Plans Ease Transitions, Lessen Burden

Most people probably don’t spend much time contemplating their own mortality. When they do, it often goes only as far as purchasing some term life insurance.

But for many business owners, the issue of who will take the helm when they leave this mortal coil should be a significant concern.

This means having a plan for the unavoidable. And the better that plan is, the better the chance that factors such as power struggles, asset disputes and other serious setbacks can be mitigated, said George Rhoads, a partner with Matthews Campbell Rhoads McClure Thompson & Fryauf PA in Rogers.

A good plan can also help minimize tax burden when passing a business on to family members.

Without a trust or estate plan, the dispensation of a decedent’s assets, including businesses, will go to a probate court.

In probate court, an attorney contacts family members, creditors and any other valid parties, to find out who might have a claim on the deceased’s assets.

Most probate cases go smoothly, but even in the best of circumstances it will take at least six months to settle. Other cases can drag on for years, if there are disputes involved.

A living trust or estate plan, on the other hand, is a self-executing document, and can be settled in two to four months.

Though a last will and testament is less expensive to set up on the front end than creating a business plan or trust, it is often costlier in the long run because of the fees involved with the probate process, Rhoads said.

Likewise, an estate plan drawn up without the assistance of an attorney or CPA can have higher unexpected long-term costs because of the greater potential for filing or execution errors, he said.

The cost of setting up a succession plan varies widely depending on the size of the business and whether the estate tax will be an issue, Rhoads said.

Taxing Concerns

One of the primary concerns for business owners looking to pass a family company on to their heirs is the issue of the gift and estate tax.

The tax itself is in a state of flux.

Right now, estates valued at more than $2 million are subject to the tax – which is about 45 percent – when it is transferred, either before or after death. If a business were worth $4 million at the time of transfer, half of its value would be subject to the tax.

In 2009, the minimum amount subject to the tax will be $3.5 million, and in 2010, there will be no estate tax at all.

Beginning in 2011, however, the tax comes back, and the minimum amount is set at only $1 million.

Barring any action by Congress, it will remain at that level.

Some in Congress have suggested setting the limit at $3.5 million and tying it to inflation as a way of settling the matter.

Because many businesses are worth significantly more than that, transferring them with the least possible tax bite requires foresight and planning.

The IRS allows an annual tax-free transfer of $12,000 in assets for each person in a family.

For example, a husband and wife could transfer $12,000 in assets to each child (and another $12,000 to each child’s spouse) every year, tax-free.

This transfer includes non-controlling shares of a business.

The IRS also allows a discount on the value of the shares, because the shares are non-controlling and would be worth significantly less to an outsider than to a family member, Rhoads said.

The amount of the discount is left up to the discretion of the owner, but could be investigated if the IRS suspects a business owner of discounting shares too much.

So if two parents owned a business worth $150,000 and wanted to transfer it to their oldest daughter, they could each give her a one-tenth, non-controlling share in the business (worth $15,000, or $12,000 after the discount) each year.

Business owners can even transfer 99 percent of a business to their children tax-free, as long as the parents maintain a 1 percent controlling interest.

Parsing Partners

There are nearly as many different types of business succession plans as there are different types of businesses.

Planning for larger, publicly owned companies is significantly more complicated than for smaller, private, family-owned businesses, said Micki Harrington, senior partner with Harrington Miller Neihouse & Kieklak PA in Springdale.

When multiple partners are involved, it’s critical to establish a plan for what happens when a partner dies.

A mandatory buyout option is fairly common in these types of businesses. This dictates that when a partner dies, the other partners are obligated to pay the value of the decedent’s share of the business to the heirs.

Mandatory buyouts are probably the most common type of arrangement for partnership-based businesses, and they can help avoid a situation where a partner’s spouse or heirs fight with the other partners, Harrington said.

Many business partners buy insurance policies to cover buyouts.  Therefore it’s necessary to establish the value of the business.

A business’ value can be highly subjective, and can fluctuate from year to year, depending on how it performs. Some plans are written so that the value of a partner’s share will be adjusted for inflation.

Sometimes, parents might decide to leave their business to one child they feel is more interested or capable of running the business than the others. They might decide to leave the other children with different assets to ensure an equal distribution of their estate.

At first blush, a business might seem more valuable than other assets, so it’s important that all potential heirs know the value, as well as the hidden expenses and hassles, of owning a business.

Family Affair

Passing the family business on to one’s children is something many business owners might not think about in the early days of the company.

Day-to-day concerns about payroll, inventory and overhead costs can overshadow the bigger picture of the years to come. But there are many factors to consider when it comes to deciding who will succeed you.

“For me, the first decade I was in business, those things never even crossed my radar screen,” said Michael Baker, owner of Houndstooth Clothing Co. in Fayetteville.

“It was more, ‘is this thing going to work?'”

But when his four-year-old asked to go to work with him one day, it changed his perspective somewhat.

“You think, ‘hey, they might want to do this someday,'” he said.

Baker doesn’t have an exact succession plan in place now, but said he will draft one as his business matures, keeping in mind the needs of his employees as well as his family.

“Key employees are important and you’d want them to have a chance to continue their work before you up and out-of-the-blue sold it to someone or shuttered the doors,” Baker said.

Bill Mathews and his brother Walter own 31 McDonald’s restaurants across Northwest Arkansas. His son just started college and his daughter just graduated college, while Walter Mathews’ son owns a McDonald’s in Muskogee, Okla.

Bill Mathews doesn’t have a specific business succession plan. But he and his brother plan on working for another 15 years or so.

“Of course, everybody has an estate plan,” he said.

“But we’re still growing, we feel like we’re young and we enjoy what we’re doing.”