Transferring the Family Business to Family Members

When families of business owners get together, whether for holidays or family celebrations, sometimes discussions turn to the future ownership of the business. This blog will look at various considerations important to the transfer of a family business within the family.

  1. Overriding considerations in making a transfer
    • Transfer of management is different than transfer of ownership
    • Intent/reason for transfer
      • Transferor considerations
        1. Illness
        2. Retirement
      • Transferee considerations
        1. Desire to operate business
        2. Desire to grow business
    • Commitment
      • To the concept of transfer- a true intention to make a transfer
      • To the process of transfer- a true intention to follow through with the steps of making a transfer
    • VALUE of the business
      • Should be obtained from an appraiser or business broker
      • Fair market value is NOT the same as “book value”
      • CRITICAL in interfamily transfers
        1. Tax attributes of sale are normally based on fair market value
        2. By using an independent valuation family harmony is promoted
    •  Communication
      • With the transferee
        1. In both act and writing
        2. In documentation
          • Minutes
          • Agreements
      • With the other employees-in both act and writing
      • With vendors/customers-in act
    • Preparation for transfer-mentoring is key
  1. Considerations in making lifetime transfers
    • For payment (Buy/Sell Agreements or Purchase Agreements)
      • Purchasing can “equalize” an estate
      • Terms of purchase
        1. Price
        2. Terms of payment
      • Can “fund” retirement
      • Creates an income taxable event for Seller
    • Drawbacks to sales to family members
      • A “bargain sale” (sale at lower than fair market value) may be disregarded for Estate tax purposes[1]
      • Sale at price OTHER THAN independently determined fair market value can create family “disharmony”
        1. Purchaser feels they are re-purchasing their own efforts
        2. Purchaser feels they are overpaying to fund the retirement of the Seller
        3. Non-Purchasers feel that Purchaser is getting a “bargain” even if they are not
    • By gift
      • If recipient is at a lower tax bracket then transferee, can result in reduction of overall income tax to family
      • Can reduce taxable estate of donor
        1. Estate tax starts at $5.45 Million
        2. Annual gift exclusion is still $14,000
        3. Gifts of business interests can be discounted so that $14,000 of “value” can transfer more than a proportionate share of the business
      • Can create a tax problem for recipient because the recipient’s “basis” for tax purposes is the same as the tax basis of the donor[2]
    • Lifetime transfers can be a combination of gift and sale
  1. Consideration in making post-mortem transfers
    • Income tax implications
      • Due to the step-up in basis to fair market value at the date of death[3] the Estate normally has no income tax as the result of the sale
      • The recipient of a business from an Estate takes the Estate’s basis[4]. Accordingly, if the recipient sells the business there may be less income tax due on the sale than if there is a lifetime gift of the business.
    • For payment
      • Will can establish an “option” to a family member to “buy out” the interests of others
      • Buy/Sell agreement could be established during lifetime to take effect at death
      • Due to the step-up in basis to fair market value at the date of death[5] the Estate normally has no income tax as the result of the sale
    • By bequest
      • Equal is not always fair and fair is not always equal
      • Non-participant beneficiaries of a business often become “experts” to the dismay of the participant beneficiaries
      • We recommend bequest of the business to a participating beneficiary, but some corresponding bequest to a non-participating beneficiary (such as life insurance)

At the Kreamer Law Firm, P.C. we focus our practice on business law as well as estate planning/probate. Contact us at 515-727-0900 or at info.kreamerlaw.com for assistance with transferring your business to family members.

[1] IRC §2703

[2] IRC §1015

[3] IRC §1014

[4] IRC §1014

[5] IRC §1014

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