COVENANT BUSINESS PLANNING SOLUTIONS

Transfering Wealth to Children: A Primer for Business Owners

In their desire to pass wealth to children, business owners are no different than non-business-owning parents. You want the best for your adult children which, you believe, means continuing your legacy. But unlike the general public, business owners have different tools you can use to transfer wealth and protect that legacy.

Whether you own a business or not, the fundamental questions are the same:

  1. How much wealth do you want to keep?
  2. How much wealth do you want the kids to have?
  3. How much is too much?
  4. What tools minimize the Estate and Gift Tax consequences of transferring wealth?

But those questions are predicated on how you answer the following question: “How much money do you wish to have after you exit your business?”

Once owners establish their financial exit objective, they can answer the universal questions above and design a transfer mechanism that will pass the wealth to the children with minimal tax impact.

This three-part process is the subject of this blog. Let’s talk about how to:

  1. Fix the owner’ s financial objectives before considering a wealth transfer;
  2. Determine the amount of wealth to be transferred (and determine how much is too much); and
  3. Design a wealth transfer strategy that keeps the IRS from becoming the largest beneficiary of your hard-earned cash.

To illustrate how a business owner might answer these questions, let’s look at the case of George Delveccio, a composite of a number of successful business owners.

George opened his meeting with his estate planning attorney with an announcement, “I think I’ve waited too long to begin gifting part of the company to my son, Chad, who runs the business with me. My CPA just told me that my company could be worth between $12 million and $15 million to a third party because it consistently generates $2.5 million in cash flow annually. I had no idea it could be worth so much!”

Business owners have to put those questions in the context of their exit objective: “How much money do you wish to have after you exit your business?”

Once owners establish their financial exit objective, they can answer the universal questions above and design a transfer mechanism that will pass the wealth to the children with minimal tax impact.

George’s advisors should then help Mr. Delvecchio determine his own financial objectives before considering a wealth transfer.

George tells them he has been saving a significant percentage of his earnings for the past twenty years and, combined with investments and bonds, feels that he has sufficient wealth to sustain his retirement. Now, he says, he’s more focused on how he can benefit his son Chad.

“Since I don’ t need that much, I want to transfer at least half the value of the business—at a lower valuation of course—before any possible sale. I know I can give small chunks of stock to Chad in amounts equal to my annual exclusion and I’m willing to consider using part of my $5 million lifetime gift exemption.

“I want to keep most of my estate tax exemption to provide the same level of benefit for my other two children. My wife thinks we should give those two the same amount I want to give Chad—just not using business interest as the gift.

“My CPA told me to meet with you because she thinks there are ways to increase the amount of my gift to Chad without paying gift taxes— especially when combined with
gifts to the other two, non-business-active kids. Well? I’m all ears.”

George’s attorney pointed out that using both his and his wife’s annual gift exclusion amounts and his $5 million lifetime gift exemption were sound ideas, but, used alone, would not transfer even half of his total wealth (about $25,000,000) to his children. Even combining George’s and his wife’s full lifetime gift exemptions, the transfer to the kids would be well less than half of their total wealth.

Compounding the problem were two issues: 1) the fact that George had good reason to believe that the company’s cash flow would continue to grow, from its current $3 million by at least 25 percent per year for the next three years; and 2) the uncertainty about whether the estate tax exemption would remain at $5 million.

“Given how much more valuable my business will be in a few years, won’t it be even more difficult to transfer wealth to the kids? How can I give my kids as much money as possible without paying any more in taxes than absolutely necessary?”

George’s prediction of rapid future growth was music to his attorney’s ears. “George, the more rapidly your business grows in value...the more cash it spins off...the easier it is to give wealth away and give it away quickly - with little or no gift tax consequences.”

The attorney suggested that George and his wife answer the first two questions (How much wealth do you want to keep? How much wealth do you want the kids to have?) and that they all meet in a few weeks to explore answers to the third.

Take advantage of this opportunity to transfer wealth to your children. Check out www.CovenantBusinessSD.com for more information.