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Business Succession Plans and Taxes

Although business succession planning involves analysis of many different aspects of a business, from human resources to marketing, one fundamental legal and financial issue is critical to efficient business succession planning: estate and gift taxes.

With the exception of estate taxes in 2010, when a person dies, his/her estate may be subject to substantial tax liabilities. Unless Congress acts before January 1, 2011, that tax liability will be 55% of a person's assets in excess of $1 million starting in 2011 and going forward. However, there are ways to both minimize and pay this tax liability via discounting, freezing, life insurance.


The value of a business, and any tax associated with transferring ownership in it, is determined by examining a myriad of different factors. Some factors cause increases, while others cause decreases, in business value. In specific, there are two principal types of discounts that may be applied to decrease business value: a discount for lack of control and a discount for lack of marketability. Depending upon the validity of the discounts applied, the IRS may allow the owner(s) of a business to significantly reduce future gift and estate tax liabilities.

A discount for lack of control can often be applied to those interest holders that do not have controlling interests in the business, e.g. a 5% voting interest. A discount for lack of marketability can often be applied when interest holders cannot readily sell their interests in the business, e.g. the business is not publicly traded.

For example, a parent owns 100% of a non-pulicly-traded business. He/she has three children to which he/she would like to give all of his/her interests in the business. If the parent gives an equal share of the business to each child, i.e. 33%, the values of the children's interests for gift tax purposes can be discounted substantially because nobody now owns a controlling interest in the business. Also, because the business is not publicly traded, the parent will likely be able to further discount the values of the children's business interests because of lack of marketability. 


If a business owner believes his/her business' value will increase substantially in the future, the owner can transfer the business out of his/her estate which will allow any future increase in the business values not to be included in his/her estate, but he/she will need to pay gift taxes on his/her present interests in the business at the time of the transfer.

For example, if a person transfers his/her business ownership interests to a trust and subsequently transfers some of his/her interests in such trust but retains sufficient benefit from the trust for a fixed period of years, future increases in the value of the business will not be included in the person's estate, but he/she will need to pay taxes on the gifts to the trust in excess of his/her lifetime exemption of $1 million.

While Congress permits the transfer of business interests out a person's taxable estate to occur, such transfers must conform to numerous and complicated restrictions in order to ensure such transfers are honored and recognized as valid.

Life Insurance

Once the estate tax liabilities associated with transferring a business have been calculated, the owner(s) of the business must determine how to pay those taxes. One of the most common ways to pay the estate taxes of business owners is for the business to take out a life insurance policy upon the lives of the owners in the amount of projected estate tax liabilities. When a business owner dies, the business will effectively pay the owner's estate taxes associated his his/her business interests via the proceeds of the life insurance policy.

This brief overview of some important considerations associated with business succession planning and taxes is by no means comprehensive. Always seek the advice of a competent professional when making important business and estate planning decisions.

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