With or without you

A succession plan provides direction for what needs to happen the day you’re no longer there.

Sooner or later, everyone thinks about retirement. For those who own a closely-held or family garden center business, retirement is more than just a matter of deciding not to go to work anymore. In addition to ensuring there will be enough money to retire, business owners, shareholders and partners must decide what will happen to the business when they are no longer in control.

An effective succession plan can involve selling the business to provide a retirement nest egg, or continuation of the business, with gradual changes in management and/or control, to ensure a source of retirement income or any combination thereof.


Planning basics

At its most basic, a succession plan is a documented road map to be followed in the event of the owner, partner or shareholder’s death, disability or retirement. This plan can include a program for distributing the stock of the operation and other assets, retiring the operation’s debt, obtaining life insurance policies, buy-sell agreements between partners and heirs, dividing responsibilities among successors and any other elements that affect the business or its assets.

Although tax planning should never control any business decisions, estate taxes play a big role. Tax law changes in 2001 contained a one year elimination of the so-called “death tax.” The estate tax rose from the grave at the end of 2010, with a Bush-era top rate of 35 percent and an applicable exclusion amount of $5 million ($5.12 million in 2012). In 2013, the death tax will revert to its antiquated, pre-2001 form. The applicable exclusion amount will plummet to $1 million, and the top marginal rate will leap 20 points to 55 percent. A 5 percent surtax will also return, to be levied on estates between $10 million and $17 million. This raises the top effective rate of the death tax to 60 percent.


Giving it away
Because a key way to reduce estate taxes is to lower the value of assets that are in the estate, “gifting” strategies can legitimately lower any owner, partner or shareholder’s tax liability. Fortunately, there are several ways to make gifts outright, and all serve to reduce the overall estate:

  • Annual gift tax exclusions: Currently, property valued at up to $13,000 per year per donee (i.e. person gifted) may be gifted without any gift tax consequence.
  • Other gift tax exclusions: Gifts for the purposes of the donee’s health or education are excluded from gift tax calculations (this is why parents could seemingly pay unlimited amounts for their children’s doctor appointments and, for some lucky ones, schooling expenses).
  • Lifetime gift tax exemptions: In 2011 and 2012, giving lifetime gifts totaling up to $5 million before any estate, gift or generation-skipping taxes are imposed are possible.


Unfortunately, none of these gifting strategies directly benefit the garden center business. Other strategies for transferring the retail operation or business do exist, however, they are strategies that frequently include retaining control.


Flipping for FLPs

By controlling the business through a “family limited partnership” (“FLP”), or a “family limited liability company” (“FLLC”), everyone can get the added benefit of gifting shares at considerable discounts. A FLP or FLLC can assist in transferring a business interest to family members.

First, a partnership with both general and limited partnership interests is created. Then, the business is transferred to this partnership. A general partnership interest is retained for the owner, allowing a continuation of control over the day-to-day operation of the business. Over time, the limited partnership interest is gifted to family members.


Buy/sell agreements

A buy-sell agreement, often called “business prenup” is a legal contract that prearranges the sale of a business interest between a seller and a willing buyer.

A buy-sell agreement allows the seller to keep control of his or her interest until an event specified in the agreement occurs, such as the seller’s retirement, disability, or death. Other events such as divorce can also be included as triggering events under a buy-sell agreement.

When the triggering event occurs, the buyer is obligated to buy the interest from the seller, or the seller’s estate, at its fair market value (FMV).The buyer can be a person, a group (such as co-owners), or the business itself. Price and sale terms are prearranged, which eliminates the need for a fire sale if the owner, partner or major shareholder becomes ill or dies.


Selling it to the employees

An Employee Stock Ownership Plan (ESOP), allows the owner of an incorporated business to sell his or her stock to the ESOP, and defer the capital gains tax.

Ownership can be transferred to store’s employees over time, and the business can obtain income tax deductions for contributions to the plan.

An ESOP provides a market for the shares of owners who leave the business, a strategy for rewarding and motivating employees, as well as benefitting from available borrowing incentives, and acquiring new assets using pretax dollars.


An outright sale
To keep the income rolling in without having to show up for work every day, succession planning might look at selling an owner, shareholder or partner’s interest in the business outright. When the business interest is sold, the seller receives cash (or assets that can be converted to cash) that can be used to maintain the seller’s lifestyle, or pay his or her estate taxes.

The time to sell is optional - now, at retirement, at death, or anytime in between. As long as the sale is for the full fair market value (FMV) of the business, it is not subject to gift tax or estate tax. Of course a sale that occurs before the seller’s death may be subject to capital gains tax.


Liquidity strategies=cash

So-called “Liquidity” strategies permit a business owner to take cash out of the business in exchange for the transfer of assets to another individual. While liquidity options are most common with sales of the business are to a third-party, they can also be used when the assets are being transferred to family members or business insiders (such as partners).

A private annuity involves the sale of property in exchange for a promise to make payments for the rest of the seller’s life. Here, ownership of the business is transferred to family members, or another party (the buyer). The buyer, in turn, makes an unsecured promise to make periodic payments for the rest of the seller’s life (a single life annuity), or for the seller’s life and the life of a second person (a joint and survivor annuity).

A joint and survivor annuity provides payments until the death of the last survivor; that is, payments continue as long as either spouse is still alive. Again, because a private annuity is a sale and not a gift, assets can be removed from an estate without incurring gift tax or estate tax.

A self-canceling installment note (SCIN) permits the transfer of the business to a buyer in exchange for a promissory note. The buyer must make a series of payments to the seller under that note. A provision in the note states that upon the owner’s death, the remaining payments will be canceled. SCINs provide for a lifetime income stream and avoidance of gift tax, and estate tax in a manner similar to private annuities. Unlike private annuities however, SCINs give a security interest in the transferred business.


Successfully planning succession

Developing a succession plan is a multi-phase process outlining, in detail the, who, what, when, why and how changes in ownership and management of the business are to be executed. At a minimum, a good plan should:

  • Transfer control according to the wishes of the operation’s owner, shareholder or partner;
  • Carry out the succession of the business in an orderly fashion;
  • Minimize the tax liability of all involved;
  • Provide economic well-being after the owner or partner steps aside.


Business owners seeking a smooth transition should seek competent, experienced advisors to assist them. No matter how talented professional advisors are, their limited specialties should never dictate the choices for the business or the owner or partner’s family.

A tax lawyer can make compelling arguments for strategies to minimize estate and gift taxes. A CPA can suggest strategies for controlling income taxes. It’s a similar story with financial planning and insurance professionals. In fact, tax planning should never control any business decisions.

Finally, succession planning isn’t something that can done once and forgotten. To be complete and effective, a succession plan must be continually revisited, reviewed and updated to reflect changes in the value of the garden center operation, market conditions, and the owner or partner’s health, as well as the abilities and passion of the people it will be passed on to.


 

Mark E. Battersby is an Ardmore, Pa.-based finance writer.

January 2013
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