Estate Planning: Difference Between Sale and by Gift/Inheritance Transfer

Have you taken steps to ensure a smooth transition of your business after you are no longer involved?  Many business owners think about what they would like to happen to their business, but fail to actually put a succession plan in place – often with disastrous results.  If you don’t have a formal plan in place, you’re not alone.  According to a recent survey of small business owners, seven out of ten say they have thought about who would run their business in their absence, but only 25 percent actually have formal retirement succession plans. Only 35 percent have formal continuation plans in the event of a premature death.[1] 

Once you have identified “who” you would like to take over your business, the next step is to figure out the details – the “when” and the “how” of your transition plan.  There are basically two ways ownership of a business can be transferred – by sale or by gift/inheritance.  

Sale
The owner may decide to sell the business to a third-party buyer.  A sale of the business provides the departing owner (or his/her family) with financial resources to meet ongoing income needs during retirement or after the death or disability of the owner. 

The future sale of a business is documented using a buy-sell agreement.  A buy-sell agreement identifies the buyer and seller, when the sale will take place (the “triggering events,” like death or retirement), the sale price (or how it will be determined at the time of the sale) and payment terms.  Often, the buyer will purchase life insurance on the life of the owner or set money aside to be used to fund the purchase when the future sale takes place.  Buy-sell agreements are very flexible and can be designed to fit a variety circumstances.  However, it is a legally enforceable document and subject to state specific laws, so a local attorney who specializes in business succession planning should be utilized to draft it. 

Gift / Inheritance
Transferring the business through a lifetime gift or by inheritance will most likely be reserved for close family members.  In most cases, the business owner will not receive any proceeds from the transfer, so this option may not be suitable for everyone, especially if retirement income is needed. 

Each individual can make gifts of up to $13,000 per person, per year without incurring gift tax liability.  In 2012, the estate tax exemption – the amount you can pass to your heirs tax-free at death - is $5,120,000 per person ($10.24 million for a married couple).  Transfers over this amount are subject to a maximum tax rate of 35%.  The $5.12 million exemption can also be used for lifetime gifts.  However, this law is set to expire at the end of 2012, unless Congress acts to extend it.  If Congress fails to do so, the exemption will be reduced to $1 million and the maximum tax rate will increase to 55% on January 1, 2013.  Business owners who want to take advantage of the $5.12 million exclusion have a limited window between now and the end of the year in which to act.  If you are contemplating a gift (or a series of gifts) of your business interests, consult with your legal advisors to review the tax consequences of doing so and draft the appropriate estate planning documents.

The best option for your business – whether it’s a sale, a gift or a combination of the two – will depend on a variety of considerations and your individual circumstances.  Planning ahead and working with an attorney who specializes in business succession planning to put the plan in writing will go a long way towards making your vision for the future a reality. 



[1] Small Business Owners; 2009, LIMRA

This article is intended to provide general information and recommendations regarding risk prevention only. There is no guarantee that this information will result in reduced losses, lower premiums, or lower experience modification factors. The content provided is accurate as of June 2012 and is subject to change. This information may be subject to regulations and restrictions in your state and should not be considered legal advice. Qualified counsel should be sought regarding questions specific to your circumstances and applicable state laws. © 2012 Federated Mutual Insurance Company.

For more than a century, Federated Insurance Companies has provided peace of mind to business owners through valued insurance protection. Federated’s national headquarters is located in Owatonna, Minnesota, with a regional office in Phoenix, Arizona, and several service offices located throughout the country. Federated has more than 2,600 employees and operates in 48 states and the District of Columbia. Today more than 400 trade associations and industry organizations recommend one or more of Federated's programs. The company was rated A+ (Superior) by A.M. Best Company for 2010. For the latest rating, access www.ambest.com. Federated was also included in the 2010 Ward's 50 group of companies that have excelled at balancing financial safety, consistency, and performance over a five-year period (2005-2009).More
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