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Steve Clausen, a founding member and head of the Estate Planning and Probate Section of Clausen & Centrich, PLLC, published the following article in PKWY Magazine in the October 2016 issue:

 

SUCCESSION PLANNING FOR FAMILY OWNED BUSINESSES 

            An inevitable issue facing every family business is succession – who will replace the current owners and officers once they retire or die?  The family business owner has four basic choices to dispose of such business: (1) sell, (2) lifetime gifts, (3) transfer at death, or (4) liquidate.  Proper succession planning allows the business owner to determine which option works best for him, his family and his business.

What is a Family Business?

            A family business includes (a) two or more unrelated people who have formed a closely held business, (b) a husband and wife, (c) a parent and child or children, (d) siblings who are in business together, or (e) some other combination of the foregoing.

What Is Succession Planning?

            Succession planning involves planning for the preservation and transfer of control of an individual’s business in a manner that carries out his or her objectives. 

Probability of Succession Failure

            Statistics in one study show that only 30% of family businesses survive for more than one generation (i.e., from parent to child), only 15% of family businesses last for two generations (i.e., from grandparent to grandchild), and only 1% of family businesses survive for three or more generations.

Why Do So Many Family Businesses Fail in the Second and Third Generations?

            The leading causes for why so many family businesses fail are: Unresolved family discord such as bad management, and lack of training; lack of, or inadequate, business succession and personal planning; high taxes (death and income taxes); and unforeseen problems.

The problems associated with high taxes, bad management, and family discord can be controlled, and even eliminated, by a thorough succession plan.

Dealing with Emotions

            The owner may have a major reason to not address succession planning – the desire to avoid making two difficult decisions: “When is it time to leave the business?” and “Who should take my place?”  Succession issues also have the potential to wreak havoc, both in the business and in the family.

Four Important Facts the Family Business Owner Should Consider in Succession Planning

Succession planning is important for every family business. Failure to develop a formal succession plan will impair the family’s finances and personal relationships. Without carefully coordinated succession and personal planning much of the family’s wealth may go to pay taxes. Often times, impartial, outside advisors are necessary to help the business owner effectively solve the succession problems.

Key Questions

            To implement a business succession plan, the owner needs to resolve four distinct questions: Should the business be sold or kept under family control? If the business is to be sold, who are the potential buyers and when should it be sold? If the business is kept in the family, who should have ownership and ultimate control? If the business is kept in the family, who should be in charge of day-to-day operations?

Formula for Successful Succession Planning

What can a business owner do to successfully transfer business? Develop a clear retirement career plan for the business owner and the owner’s spouse.  Develop a realistic and shared written vision for the future of the business to guide the business when the business owner is no longer actively involved and in charge.  Select and train the successor.  Develop a process for transferring authority and power in the business.  Develop a wealth transfer plan that specifies how family assets and ownership of the business will be protected and distributed.  Design the business succession plan including management structures, family council, and board of directors.  Design a family participation plan that specifies understandings and rules for future family involvement in the business. 

Summary

            Remember that succession planning is a process, not an event, and it is more than simple estate or retirement planning – it’s part of a comprehensive wealth transfer plan.  It is the blueprint that guides the owner and family in successfully dealing with perpetuating the family business.

 

Contact us to arrange a consultation and learn more about Clausen & Centrich's unique approach to meeting the legal needs of your growing business.

CLIENT ADVISORY BULLETIN

The Department of Treasury’s recently issued Proposed Regulations under Section 2704 once they become final would adversely impact the estate planning for some business owners by eliminating certain valuation discounts as well as reducing the ability to leverage the maximum amount of assets out of harm’s way due to divorce, lawsuits or other claims.

Proposed Regulations Recently Issued: The Department of Treasury (“IRS”) recently issued Proposed Regulations that could have a dramatic impact on your estate planning by eliminating valuation discounts. For high net worth individuals looking to minimize their future estate tax, this is critical. It can also be important for others as well. If you are concerned about protecting a family business from the risks of future divorce, or protecting your assets from lawsuits or other claims, discounts can enable you to leverage the maximum amount of assets out of harm’s way, without triggering a gift tax to do so. 

Act Now: Time is of the essence. Once the Proposed Regulations are effective, which could be as early as year-end, the ability to claim discounts might be substantially reduced or eliminated, thus curtailing your tax and asset protection planning flexibility. 

What are Discounts Anyway? Here’s a simple illustration of discounts. Tom has a $30M estate which includes a $15M family business. He gifts 40% of the business to a trust to grow the asset out of his estate. The gross value of the 40% business interest is $6M.  Since a minority 40% trust/shareholder cannot force a sale or redemption of its interest, the non-controlling interest in the business transferred to the trust is worth less than the pro-rata value of the underlying business. Thus, the value should be reduced to reflect the difficulty of marketing the non-controlling interest.  As a result, the value of the 40% business interest transferred to the trust might be appraised, net of discounts, at $3.6M. The discount has reduced the estate by $2.4M from this one simple transaction. 

Election Impact: If the Democrats win the White House and the Democratic estate tax proposals discussed below are enacted, the results will be devastating to wealth transfer planning. Pundits have prognosticated that a Democratic White House could affect down-ballot races and flip the Senate to the Democrats. The Democratic tax plan includes the reduction of the estate tax exemption to $3.5M, elimination of inflation adjustments to the exemption, a $1M gift exemption and a 45% rate. The Democratic plan will most likely include the array of proposals included in President Obama’s Greenbook which seek to restrict or eliminate GRATs, installment sale transactions to grantor trusts, and more. Wealthy taxpayers who don’t seize what might be the last opportunity to capture discount planning, might lose much more than just the discounts. They might lose many of the most valuable planning options. 

Not a 2012 Boy Who Cried Wolf: Many of you might remember the mad rush to plan in late 2012 on the fear that the gift, estate and generation skipping transfer (GST) tax exemption might be reduced from $5M to $1M in 2013. After many incurred significant costs and hassles in implementing planning quickly, that change never occurred. For those who might be affected by discounts, the situation in 2016 seems vastly different. The Proposed Regulations could be changed and theoretically even derailed before they become effective. The more likely scenario is that they will be finalized after public hearings and the ability to claim valuation discounts will be severely curtailed. If you do undertake planning, be cognizant of an important lesson from much of the planning that was done in 2012. Consider using planning techniques that assure you (or if you are married, your spouse) access to funds transferred in the discount planning. The main regrets in 2012 planning were for many of those who transferred assets out of their own reach. 

What You Should Do: Contact your planning team. A collaborative effort is generally essential to have your planning done well. Your estate planning attorney can review strategic wealth transfer options that will maximize your benefit from discounts while still meeting other planning objectives. Projections completed by your wealth manager or other financial advisor could be essential to confirming how much planning should be done and how. Your CPA will have vital input on wealth transfer options, federal and state income tax implications, and more. Your insurance consultant can show you how to use life insurance to backstop some of the planning strategies, in coordination with the financial forecasting done by your wealth manager, or financial advisor to maximize both the tax benefits and your financial security. 

Options to Consider: If estate tax minimization is a primary objective, then the following options should be considered: (i) if there is already an existing entity such as a corporation, limited partnership or limited liability company, then gifts of the equity interests to various types of your irrevocable trusts, including spousal access trusts of which one of the spouse’s is the primary beneficiary, should be considered, (ii) installment sales of the equity interests to an irrevocable trust that is a grantor trust for federal income tax purposes, or (iii) if there is not already an existing entity, then a family limited partnership or a family limited liability company could be formed so that the type of discount planning described in clauses (i) and (ii) immediately preceding could be implemented.

If asset protection is a primary objective and there is not already an existing entity, then a family limited partnership or a family limited liability could be formed so that discount planning could be used to maximize the amount of property that would be given away to a trust that was designed for asset protection, which would include a spousal access trust.

It is likely our fourth quarter will be very busy helping clients who want to take advantage of the discount planning opportunities that are currently available so do not delay if you want to implement discount planning before the Proposed Regulations become effective.

 

I would guess that for the vast majority of the people who moved to The Woodlands some of the  primary reasons  were to enjoy a quieter life style the hustle and bustle of Houston could not provide and a better place to raise and educate a family.  It is also a certainty people did not move here to encounter horrid  traffic problems that make it difficult to get into and leave The Woodlands.  Over time, the amenities The Woodland has to offer has caused more and more people to move here,  while at the same time overwhelming an infrastructure that is clearly inadequate for the existing population let alone the additional residents and businesses that will be arriving. 

Whether you are for or against more growth, steps to solve the infrastructure problems must be implemented soon because traffic on the roadways is only going to get worse as is the parking situation at Town Center.  Why has the traffic situation gotten so out of hand in The Woodlands and numerous other areas in Montgomery County?   A lack of leadership in  various levels of government,  a misplaced focus of certain special interest groups, and voter apathy! 

It is my understanding that the last successful bond issue for roads in Montgomery County was over ten years ago.  How is that possible given the dramatic growth in South County, which affects all of Montgomery County to some degree?  A lack of political will has allowed the traffic situation to get out of hand.  A bond package for adequate roads should have been a recurring ballot item until it passed—but that approach was not taken and here we sit in ever increasing traffic.   Finally, the Commissioners have approved a bond proposal—one that is not large enough and does not allocate enough money to The Woodlands—but at least a step in the right direction. 

The response—a divided community in which opponents of the current proposal are willing to try to secure its defeat because of the controversy over the extension of The Woodlands Parkway to Highway 249.  Yes, it would have been much better to increase the size of such parkway going East too, but Rome was not built in a day and neither will be all of the necessary road additions.  Common sense screams that construction on new roads must start sooner rather than later or the gridlock will become much worse—both coming into and leaving  the Woodlands. 

If anyone needs a history lesson about the effect of a  policy of not building roads to try to keep people out, one only has to look at Austin.  A great city that is overwhelmed by traffic with no meaningful plans in place to  begin to solve the traffic problem.  If you want the gridlock in The Woodlands and the rest of Montgomery County to increase, then oppose the bond issue.  If you want to start to improve mobility, then vote for the bond proposal and let your elected officials know the current proposal is only a good start and much more infrastructure is needed to solve the traffic and parking problems.

President Obama's new tax proposal has a number of changes that could drastically impact your estate plan or business. First, it would treat bequests to non-charitable beneficiaries as gain realization events. Currently, there is a step up in basis with no gain recognition.

The outline of the proposal includes:

  • Basis step up, but only because gain is recognized currently
    • This proposal is less favorable than simply denying a basis step up because it accelerates gain recognition
  • Exemption for first $200,000 of capital gain for married couples ($100,000 for individuals)
  • Exemption applies only to gains, not to value of assets transferred, so assets with a higher value could be bequeathed tax free
  • Exemption automatically portable between spouses
  • For couples, no tax would be due until the death of the second spouse
  • No tax due on inherited small inherited family-owned and operated businesses unless and until the business is sold
    • Any closely-held business would have the option of paying the tax on gains over 15 years
  • Bequests or gifts of tangible personal property other than expensive art and similar collectibles would be tax-exempt

Retirement Planning Changes

The new proposal would prohibit contributions to and accrual of additional benefits to qualified plans and IRAs when balances are sufficient to provide an annual income of $210,000 in retirement

  • Current maximum allowable balance would be about $3.4 million
  • Employers with more than 10 employees but no retirement plan would be required to enroll all workers in an IRA (auto-IRA)
    • Tax credit of up to $3,000 for employers with up to 100 employees that offer an auto-IRA

In addition, the administration has recently withdrawn its proposal to tax 529 savings plans.

While it seems unlikely that these proposals will pass Congress, any such changes to the tax code could greatly impact your individual or business. Attorneys at Clausen & Centrich will keep you informed about changes that could impact your estate planning, business or succession planning.

      We occasionally receive inquiries asking about our estate planning services and then trying to compare our quoted price to that of a self-help provider, such as LegalZoom. But does LegalZoom really provide you with the protection you need for your family?

      According to LegalZoom’s website, you can “Save time and money on common legal matters! Created by top attorneys, LegalZoom helps you make reliable legal documents from your home or office. Simply answer a few questions online and your documents will be created within 48 hours. We even review your answers and guarantee your satisfaction.”

       Today, nearly all successful businesses have websites. As part of the process of building a website, most companies hire an attorney experienced in contracts and business law to draft “Terms of Use” that govern the relationship between the company and any users of its website. These Terms can be extremely important, and can govern everything about the conduct of the user on the website such as IP ownership clauses and licenses, as well as limitations on damages, forum selection clauses, mandatory arbitration, and class waivers in the event of a legal dispute or lawsuit between the parties.