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Small Bites Podcast: Planning for the late-stage business owner

October 2, 2023
Planning for late-stage business owners

In this final episode of season two of Small Bites of Business Insights, hosts Dr. Kathy Gosser and Rebecca McDade, J.D. discuss crucial estate and transition planning for late-stage business owners, addressing fair treatment for children, exploring charitable planning and advanced wealth transfer strategies, that ensure family cohesiveness and responsible wealth utilization.

Dr. Kathy Gosser, YUM! Assistant Professor of Franchise Management and Director of the Yum! Center for Global Franchise Excellence

Rebecca McDade, JD – Attorney

(NOTE: This is an automated transcription and not intended to be used as a substitution for listening to the podcast recording. Simply click on the player above and receive the full benefit of the conversation.)

And welcome to this episode of Small Bites of Business Insights. It’s Talking Wealth Planning and with me, I have Becca. Hey, Becca. Hey, Kathy. Nice to see you again. Always good to see you. And now we’ve talked about early stage business owner, mid stage business owner. Now we come to planning for the late stage business owner.

What type of planning should this late stage business owner be thinking about? So with late stage, you’re probably wanting to mosey on out of the business in some way shape or form. So now’s a good time to, if you haven’t done your basic estate plan, like we’ve talked about at the earlier stages, you want to put together an estate plan, um, but hopefully you’ve already got one in place.

And so now’s a good time to review it. As with the mid stage, um, when you’re reviewing your estate plan, things will have changed. So there may be more grandchildren, there may be marriages and divorces, but now becomes a harder decision with how you’re going to treat the children. Often with businesses, you’ve got one or two children that want to succeed you in the business and one or two children who do not.

So, how do you treat your children equally and or fairly when your largest asset is the business? So, reviewing your estate plan to address either equal or fair treatment for your children is going to be really important. Things to think about with that is the use of insurance to help offset the distribution to the non participating children.

I also will look at bifurcating the real estate versus the business. Oh, okay. Um, or I might restructure the business. So oftentimes when people create a business, they have one class of stock and that’s voting stock. I could recharacterize the business to have voting and non voting stock. And that way the children who are active in the business would get the voting stock.

And those who are not would get the non voting stock, but the children would still be able to share equally. So for the late stage business owner, there are going to be things that you’re going to need to consider when you’ve got children who are participating and also not participating in the business.

Now would be a good time to also look at charitable planning. So it might be that you just become more charitably inclined as you’re hitting later in life. And so you want to be more strategic in the charitable giving that you’re providing. Um, there are income tax and transfer tax advantages to charitable planning.

And so even though you’re charitably inclined, you can do it in such a way that you are getting income tax and estate tax advantages. The other thing is, if as a late stage business owner, you’re looking to sell your business, You can transfer some of your business to a charitable entity, not a charitable organization so much as a charitable entity and avoid capital gains tax on the shares that are held by the charitable entity when the business is sold.

So that would overall reduce. The tax ramifications of a sale of your business. So reviewing your overall estate plan and looking at charitable planning are the two big things that I would think about with estate planning for the late stage business owner. I do know one thing I learned recently on charitable planning.

Say you have an IRA, you can actually carve out a, an IRA. And make that your charitable destination, the beneficiary. And so upon your death, they immediately get the payout and there’s no tax implication. Is that true? Yes, it is. So, um, what generally happens with IRAs just to expand out a little bit is when you create a traditional IRA.

You’re putting in pre tax dollars, right? And when you take a distribution out of your IRA, you’re having to pay ordinary income tax on it. The same happens with your beneficiaries. So if your children are the beneficiaries of your IRA, whenever they take a distribution from the IRA, they’re having to pay income tax on it.

Charitable organizations are tax free entities. So you avoid that income tax, which is a good thing. So the charity gets a distribution from you and your children are getting assets that don’t come with a built in income tax liability. So that’s an excellent point, Kathy. That was something I learned and I thought, Ooh, that’s pretty smart.

And then the charitable institutions really gain from that. I mean, that’s a good thing for them too, because there’s no probate or any argument. They’re automatically the beneficiaries. And back to that. Yes, somebody may be charitably inclined, but oftentimes we run across people who are more charitably inclined when there’s a tax benefit.

So charitable organizations are getting more because people are using it as a tax benefit. There is that. You’re right. So at this stage, they should be thinking about transition planning. So what are the components of that? They absolutely should be looking at transition planning now. Um, because that transition is either going to be on their terms or it’s going to be as a result of their death.

And in the midterm planning section that we had, we talked about some of the things that the late stage business owner should also be looking at. You want to make sure employees are sitting in the right seats. Right. Doing the right jobs. Um, you want to look at who’s going to be buying the business and how they’re going to be paying for it.

And you’re going to want to make sure that however you structure the sale. So this would be happening during your lifetime. You’re not putting your retirement at risk, um, which goes back to primarily not selling on installments. If you don’t have sufficient other assets for your retirement, that’s not only a risk to your retirement selling on installments, it’s also a potential risk to your legacy.

What the beneficiaries are going to get because they’re dependent on the buyers. Running the business well and still being able to make those installment payments, but as you get, um, older as the late stage business older and closer to retirement and death, understanding who’s going to be taking over makes a lot of sense.

I did have one client once who we kept talking to him about transition planning and he said, my transition plan is in this envelope. I like working with the people that I’m working with and I don’t want that to change. So in this envelope, I put who my successor is and they’ll open it on my desk. Oh, and, and that’s when all the fallout will come and the key employees will not have been able to have built a relationship with the new owners.

And I mean, it was, it was going to be a disaster. He hasn’t died yet. Thank goodness. But that is not a transition. That’s right. That’s right. That’s a disaster waiting to happen. Yes. Yes. So anyway, so, so transition planning as part of that transition planning, let’s say that the idea is that the business is going to be going to your children.

So what we’re looking at there is sophisticated wealth transfer strategies. And those wealth transfer strategies are going to take advantage of your 12. 9 million. Exemption. And as long as you have the business, well, not as long as if we’re using the business, for example, um, we can also incorporate valuation discounts into our wealth transfer strategies.

So as an example, if I want to transfer 30 percent of my business, To my son as part of my transition plan and I’m going to sell the other 70 percent to someone else One of the ways that I can get that 30 percent to my son is to gift it to him So I’d be using my twelve point nine million dollar exemption Because my son would be getting a minority interest Just 30 percent of the company, and he would not have control over his share because he’s a minority holder in the company, right?

I would be entitled to a valuation discount on what I’m transferring to him. So that 30 percent might be worth. 10, 000, 000 with the valuation discounts, it may only be worth 7, 000, 000. So I’d be able to use 7, 000, 000 of my 000, 000 of my exemption.

Which would lead more of my exemption for other assets that I might have outside business. Um, but valuation discounting becomes a key component to sophisticated wealth transfer strategies. That’s where you need the expert. You definitely need experts with sophisticated wealth transfer strategies. And also there are wealth transfer strategies that will allow you to transfer assets to your children while maintaining the right to pull those assets back should you need them.

So you can build in some flexibility for yourself depending on what’s happening, not only with the business, but with your cash needs. Oh, gosh, those are complex, Becca. I mean, that sounds very difficult to understand and the need for wealth planners for sure. Absolutely. The last thing that I would want to talk about is, is legacy planning.

Yes. So one of the things that happens with families that have businesses in particular. Is everybody coalesces around the business. So we might have annual meetings to talk about what dividends are coming out or what’s going on with the business. Um, everybody stays connected because everybody’s a shareholder of the business.

And so we have to see one another, but once that business is sold. It’s very easy for family members to go in different directions and you worked really hard to build this business and to build a cohesive, loving family. You don’t want them to scatter to the four corners of the earth. So, legacy planning makes sense and that takes the form of a number of things.

It could be. That you guys decide to do co investing. So you guys pull a certain amount of money and you invest in other business enterprises or in marketable securities. It may be that you decide to create a charitable foundation and everybody participates. In making donations from the foundation, I think that the most important part of family legacy planning is the family legacy.

So creating a family constitution, writing down a story about how the wealth was created. What your values are and how you anticipate your family using this wealth for generations to come and sharing that with your family at annual meetings or annual get togethers that help the family stay together.

And be more responsible about using the wealth that you’ve created. That sounds fantastic, Becca. And if you think about somebody who’s worked hard, built a company and left generational wealth, that would be a dream come true to hear the legacy continue. Absolutely. So that is wonderful. Gosh, you told us so much.

Thank you so much, Becca, for all of this information. I have had so much fun with this. Thank you for letting me do it. Of course. And good luck to all of you who are out there building your wealth.