Volume 37, Issue 1, January 2002
Steps to Take Before Retirement
by Clark Mangan
Owning a business often beats working for someone else, but ownership can complicate important personal decisions. An employee who is of retirement age can simply decide to retire and do it. Itís not so easy with a business of your own. Preserving the value of your business takes careful planning, whether you want to continue working until your heirs succeed you or if you want to retire.
Some owners arenít interested in retiring. They want to continue with their business as long as they possibly can and then leave it to their heirs. Thatís the option that has both an income-tax and estate-tax impact. For your heirs, it means an income-tax advantage. For your estate, it means an estate-tax disadvantage.
The advantage comes from the step-up that the law allows in the tax basis of inherited assets. Your heirsí tax basis in your business will be its value at the time of your death. This eliminates any potential capital gains tax liability on the growth in the businessís value during your lifetime.
That growth becomes an estate-tax disadvantage because the entire value of your business will be included in your estate for estate-tax purposes. Paying the estate tax can be a problem for your heirs if they wonít have life insurance proceeds or other liquid assets to draw on. They may have to sell the business to raise cash.
If you plan to stay in control of your business while you live, youíll need a financially sound business succession plan to assure the least overall tax impact from transferring your ownership upon your death.
Taking Your Cash Out
If you would rather retire, youíll need a way to cash out of your business. Arranging a direct sale is one possibility. However, it may be difficult to find a willing and ready buyer. Frequently, buyers are only willing if you are part of the deal. To close the sale, you may have to agree to remain on the job for a while to help the business continue to prosper. Other times, a willing buyer is short of the cash for an immediate buyout. You may have to accept the risk of an installment sale: relying on a business that you no longer control to generate your retirement funds.
Alternatives to an outright sale include using an employee stock ownership plan (ESOP) and taking your company public. An ESOP lets you take your cash out of your business by selling it to the employees who helped you build it. You affect the sale by setting up an ESOP, a type of tax-qualified retirement plan, which borrows the capital to buy your shares in your company. The ESOP then uses the businessís retirement plan contributions to gradually repay the loan. As that occurs, the ESOP trustee releases the stock to the ESOP plan accounts of the participating employees. The employees receive their vested shares upon retiring or in other circumstances, and the company must offer to buy the shares back at a fair market price.
When your company goes public, you give outside investors the opportunity to buy new stock in your company. After completion of the initial offering, you can sell your shares (following the securities regulations) to convert your ownership interest to cash as you leave the company.
Giving Your Interest Away
It may be possible to avoid the taxes that can make transferring your business on your death costly and difficult. If you are more concerned with transferring your business than with taking your money out, you can use a series of gifts during your lifetime to give away shares in your business. The tax law allows an annual gift-tax exclusion for small gifts. That lets you give an unlimited number of individuals up to $10,000 worth of stock (or other assets) each year, free of gift tax. The annual amount rises to $20,000 if your spouse joins you in making the gift. By giving to a number of family members, you can make a tax-free transfer over time of a large part of your shares.
Consult Before You Act
Planning to transfer a business interest takes specialized skills. Itís important to consult with your professional advisor before you act on any business transfer or estate plan.
Clark Mangan is a financial advisor with the Mangan, Ernst & Rankin Wealth Management Group of First Union Securities in Marlton, N.J.
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