You read this title correctly. With the right planning, delaying your company’s transfer of ownership could make sense. Still, that doesn’t mean you delay your succession planning.
Consider this scenario:
• You are the working owner of a music store, and you own the building.
• Your child or valued employee is the manager.
• You have a simple I-love-you will. (Following your death, all the company’s stock goes to your spouse.)
• You have been depreciating the value of your building for 15 years, and as a consequence, the IRS is demanding a “recapture” tax the moment you accept a note from your child.
• You are concerned about the double taxation that occurs when you sell your shares to your child or key employee, and are paid back with after-tax dollars.
Here’s an idea you may want to consider: a one-way buy-sell arrangement.
Unlike a typical cross-purchase buy-sell arrangement—in which two or more business owners own life insurance policies on each other—a one-way buy-sell arrangement only requires the purchase of one life insurance policy on the owner of the business. This arrangement can be funded with a permanent life insurance policy to provide the flexibility needed to accommodate changing needs over the lifespan of the business.
This is how it works:
1. A buy-sell agreement is established between the owner and the child manager or key manager (i.e., the successor).
2. The business agrees to pay the tax-deductible premiums for a life insurance policy on the owner.
3. The successor owns the policy and is the beneficiary.
4. The cost to the successor is the income tax due on the premiums paid by the business as a bonus. The bonus payments may be tax-deductible to the corporation when they are paid, but the payment will also be taxable to the successor. The company may also choose to make a double bonus, which is equivalent to the premiums due, plus the income tax due on the bonus.
5. At owner’s death, the successor receives the death benefit free of income tax.
6. As directed by the buy-sell agreement, the successor uses the life insurance proceeds to purchase 100 percent of business shares and the building from the owner’s estate (often the spouse of the owner).
7. Since policies are owned by a successor, the death benefit will not be included in the owner’s estate.
8. Structuring the transaction in this manner not only maximizes income-tax efficiency but also retains all of the owner’s currently available gifting capacity.
9. The successor should receive a full basis step-up for the purchase of the business interest.
10. Given enough time, the life insurance plan may also be designed to pay the owner upon retirement or disability.
Remember: Even though there’s a formal delay in selling the business, you don’t want to delay succession management. Mentoring, leadership development and preparing the successor for future ownership is critical. To do it right takes time.
You will also need to establish the value of the business. This way, you can ascertain the value of the life insurance policy that will be used to fund the buyout.
For situations where there are multiple business owners, you will have several buy-sell options to choose from, such as cross-purchase, entity redemption or cross-endorsement arrangements.
You have worked hard to make your business a success. Don’t give away the store because you didn’t have the right succession plan in place. Often, there are many techniques that can be used. Don’t delay. Ask your professional succession team for ideas.
(Note: This is not intended as professional financial advice. For more information, consult a financial professional.)
Jaimie Blackman, president of BH Wealth Management and Financial Planner, created Sound Financial Decisions to help guide music retailers and manufacturers through the complexities of succession planning. To subscribe to his Succession Success: Insights for Music Retailers newsletter, visit bhwealth.com.