It Is Never Too Early, But It Can Be Too Late: What Business Owners Need To Consider Pre-Liquidity Event
Great companies are not built in a day and your business should not be sold in one either. Business owners who are considering a sale often ask for guidance regarding an impending liquidity event and the most efficient way to implement estate structures. If a transaction is imminent, the best way (and time) to plan for this event is unfortunately behind us. But even if your liquidity event is imminent, you still may have options to consider.
Early, bespoke planning is essential and there are important income and estate tax strategies to consider. Questions that will come up during the planning process will revolve around income, spending, control, and liquidity needs. What type of access will you need to the assets to maintain your lifestyle? How much control over such assets are you willing to release to others, i.e., trustees and fiduciaries? Do you understand the complexity and flexibility around your estate?
If you are a successful business owner with an impending sale and want to effectively transfer and maximize your wealth, while minimizing income and estate taxes, consider these estate planning strategies:
Trust Planning
If your goal is to preserve the wealth that you accumulated and provide both asset protection and minimize the tax burden to your beneficiaries, then a grantor trust could be an optimal structure for your family. A grantor trust attributes the trust’s income to the grantor, meaning the grantor is responsible for the trust’s income taxes. This type of trust allows the grantor to maintain certain types of levers of control over the trust assets, such as the ability to borrow trust assets for less than adequate security or the power to swap assets for equivalent value within the grantor’s estate.
Should an additional layer of asset protection be a concern, creation of a non-grantor trust in a Domestic Asset Protection state whose laws provide favorable creditor protection will shield the assets from creditors and lawsuits. Non-grantor trusts are separate and distinct entities for tax purposes and can be paired with state income tax planning dependent on the situs of the assets and client. It is important to note that the grantor does not hold the same levers as they would under the grantor trust provisions and affords less flexibility to the grantor.
Any of these trusts can be created for the benefit of your spouse, children, extended family, friends, and future generations.
Utilize Your Gift Tax Exemption
By taking advantage of the increased gift tax exemption amount, you can make effective wealth transfers in trust for the benefit of your family and future generations. The 2024 gift tax exemption amount is $13.61 million per individual ($27.22 million per married couple) and is slated to sunset on January 1, 2026. Therefore, you should consider making use of the current gift tax exemption amount by leveraging lifetime transfers in trust prior to the end of 2025.
Explore “Freeze” Techniques: Installment Sale and Grantor Retained Annuity Trust
An installment sale to a Grantor Trust could be right for business owners whose business is valued at more than the $13.61 million exemption, as this technique removes the appreciation of the asset from your estate by selling assets in exchange for a promissory note and discounts can typically be taken on illiquid business interests further enhancing the transaction from a tax optimization standpoint. This has the additional benefit of being able to allocate generation skipping tax exemption, allowing the assets and proceeds to escape estate or generation skipping taxation for multiple generations dependent on the trust term.
Another “freeze” technique is to gift assets to a Grantor Retained Annuity Trust (GRAT). Typically, a grantor will gift an asset at a discounted value to a GRAT. The trust will then pay the grantor a percentage of the value of the assets gifted to the trust plus an implied interest rate using the IRS published 7520 rate and remove the appreciation of the asset from the grantor’s estate at a reduced rate; provided, however, the grantor outlives the trust term. A type of GRAT called a zeroed-out GRAT could be used without using any lifetime gift exemption.
It is best to discuss with your advisor which technique is most suitable for you and your family’s objectives.
Charitable Remainder Trust
If you are inclined to pursue your philanthropic goals and would welcome an income tax deduction to offset your business sale revenue, a Charitable Remainder Trust (CRT) is an effective strategy to consider. The CRT can be created so that the charity can either receive payments over the trust’s term or the remaining assets at the end of the term, depending upon the donor’s intentions and what works best at the time the trust is created. A donation of an asset in-kind to a CRT, allows you to preserve the full fair market value of the asset and reduce significant capital gains, while providing asset diversification within the CRT.
The Importance of Devising a Bespoke Plan
Selling a business is an incredibly complex and delicate journey for a business owner and their family. Summit Trail’s Planning Team offers a highly differentiated, deeply personalized estate planning service that focuses on providing clients with thoughtfully tailored guidance and comprehensive advice in structuring their pre-and post-sale financial life. It is a data-based approach that implements a forward process to business planning. Gift Tax Exemptions, Grantor Trusts, Installment Sales, GRATs, and CRTs are all good starting points for many business owners to consider, but a bespoke approach that considers the owner’s objectives and goals is an ongoing engagement for most families. Our Planning Team works closely with clients to determine which estate planning techniques align with their wealth strategies in order to maximize their post-sale outcome.
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Illustrations on pages 2 and 3:
A married couple residing in New York State with a net estate of $75MM and all their remaining estate and generation-skipping transfer (GST) tax exemption amounts are unused.
Using their Basic Exclusion Amount of $13.61MM and GST Tax exemption as of 4/3/2024 as per Revenue Procedure 2023-34 & 26 U.S. Code 26 U.S. Code § 2001
The family created a grantor trust in accordance with the provisions of 26 U.S. Code 26 U.S. Code §§ 671–678 (as recognized by NY Tax Law §601(e)(2).
Using the appropriate federal and New York State estate and GST tax deduction, exclusions and exemption amounts, the couple then gifted their entire combined federal estate tax exemption amount ($27.22MM in 2024) to their grantor trust for their children and descendants. See 26 U.S. Code 26 U.S. Code §§ 2010(c), 2012(c).
Upon completion of the split gift the couple each allocated their entire combined federal GST tax exemption amounts ($27.22MM in 2024) to the grantor trust on timely filed gift tax returns (Form 709) thereby creating a trust that is entirely exempt from death transfer taxes. See 26 U.S. Code §§2631(c), 2632(a).
