For many business owners, estate planning and succession planning go hand in hand. An owner of a closely held business likely has a significant portion of his or her wealth tied up in the business. Without proper estate planning steps to ensure that the business lives on after the owner has gone, his or her family may be placed at risk. This article explains the unique challenges presented by family businesses when older and younger generations may have conflicting financial needs.

For many business owners, estate planning and succession planning go hand in hand. If you’re the owner of a closely held business, you likely have a significant portion of your wealth tied up in the business. If you don’t take the proper estate planning steps to ensure that the business lives on after you’re gone, you may be placing your family at risk.

Separate ownership and management succession

One reason transferring a family business is such a challenge is the distinction between ownership and management succession. When a business is sold to a third party, ownership and management succession typically happen simultaneously. But in the family business context, there may be reasons to separate the two.

From an estate planning perspective, transferring assets to the younger generation as early as possible allows you to remove future appreciation from you estate, minimizing estate taxes. On the other hand, you may not be ready to hand over the reins of your business or you may feel that your children aren’t yet ready to take over.

There are several strategies owners can use to transfer ownership without immediately giving up control, including:

  • Placing business interests in a trust, family limited partnership (FLP) or other vehicle that allows the owner to transfer substantial ownership interests to the younger generation while retaining management control.
  • Transferring ownership to the next generation in the form of nonvoting stock, or
  • Establishing an employee stock ownership plan.

Another reason to separate ownership and management succession is to deal with family members who aren’t involved in the business. Providing heirs outside the business with nonvoting stock or other equity interest that don’t confer control control can be an effective way to share the wealth while allowing those who work in the business to take over management.

Work around conflicts

Another unique challenge presented by family businesses is that the older and younger generations may have conflicting financial needs. Fortunately, several strategies are available to generate cash flow for the owner while minimizing the burden on the next generation. They include:

An installment sale of the business to children or other family members. This provides liquidity for the owners while easing the burden on the younger generation and improving the changes that the purchase can be funded by cash flows from the business. Plus, as long as the price and terms are comparable to arm’s length transactions between unrelated parties, the sale shouldn’t trigger gift or estate taxes.

A grantor retained annuity trust (GRAT). By transferring business interest to a GRAT, owners obtain a variety of gift and estate tax benefits (provided they service the trust term) while enjoying a fixed income stream for a period of years. At the end of the term, the business is transferred to the owners’ children or other beneficiaries. GRATs are typically designed to be gift-tax-free.

An installment sale to an intentionally defective grantor trust (IDGT). This is a somewhat complex transaction, but essentially a properly structured IDGT allows an owner to sell the business on a tax -advantaged basis while enjoying an income stream and retaining control during the trust term. Once the installment payments are complete, the business passes to the owner’s beneficiaries free of gift taxes.

Because each family business is different, it’s important to work with your estate planning advisor to identify appropriate strategies in line with your objectives and resources.

Get an early start

Regardless of your strategy, the earlier you start planning the better. Transitioning the business gradually over several years or even a decade or more gives you time to educate family members about your succession planning philosophy. It also allows you to relinquish control over time, and to implement tax-efficient business structures and transfer strategies.

© 2019


Sarah C. Krick, CPA | CFE | CITP

Sarah began her career with Hancock & Dana in 2005 as an intern.  She joined the firm full-time in 2008, and currently serves as a manager. She specializes in SSAE 16 engagements, SOC engagements and tax services for individuals and trusts.  Sarah also has experience in financial statement audits, attestation engagements and tax services for corporations and non-profits.