How To Make Sure Your Succession Plan Is Successful

Sooner or later or later -- like it or not -- when you own all or part of a closely held business, you must wrestle with your unique "succession planning problems." The reason most readers of this column call me for help is to solve their business succession puzzle.

Now a sad fact: Most callers do not have an estate plan or, if they do, the plan is out of date. Let me be clear: Your succession plan cannot be done right unless it is part of a comprehensive estate plan.

Also most readers are not aware of their most valuable asset, often called lifetime equity growth or LEG for short. LEG is your ability to (1) earn income (of all types for the rest of your life) and (2) the value of most of your assets (because of inflation and/or simple increase in intrinsic worth) will grow over time. Plain logic tells you that your LEG is crying for a lifetime tax plan.

Remember, you ain't dead yet. Also, remember, the estate tax is harmless until you (and your spouse, if married) go to heaven. For males (a newborn), life expectancy is in the age 79 to 81 range -- add three or four years for the ladies. As you get older, the life expectancy tables move the ages up. For example, a 70-year-old male has 13 more years to live, and an 80-year old, almost eight more years.

Now, stop! Guesstimate your life expectancy. Write down how many years (and dollars) your LEG probably will increase your taxable wealth (and your potential estate tax liability). As you can see, you need a lifetime plan (to keep your LEG in the family, instead of losing it to the IRS).

An example is the best way to explain how to solve your succession plan problem.

Example: Joe (age 62) -- a real life reader of this column -- owns 100% of Success Co. (an S corporation). Joe and his wife Mary (age 57) have three children. Only one (Sam) works in the business. Joe had three main goals: (1) Avoid tax on the transfer of Success Co. to Sam; (2) Treat the two non-business kids fairly; and (3) create an estate plan that gets all his wealth to his family without being clobbered by the estate tax monster.

Following is a brief description of the plans (of course, they all dovetail) created for Joe. (In the end, one comprehensive plan.)

No. 1. Your Best Succession Plan Strategy

This easy-to-do strategy, called an intentionally defective trust (IDT), accomplishes Joe's goal -- no tax to Joe when Success Co. is transferred to Sam. A professional appraiser valued Success Co. at $15 million, but because of discounts allowed by law, Success Co. was sold to the IDT for $9 million. Joe kept control of Success Co. by retaining the voting stock (100 shares) and selling the nonvoting stock (10,000 shares) to the IDT.

An IDT saves about $200,000 (in taxes for the buyer and the seller combined) for each $1 million of the price (here Joe and Sam saved $1.8 million in taxes... 9 times $200,000).

No. 2. Solving the Non-Business Kids Problem

Joe does not want the two nonbusiness kids in the business (a typical family business owner's desire), yet he wants to treat these two kids equally (to Sam). But here's the killer that none of Joe's professionals could solve: Success Co. is worth $15 million (before discounts), but all of his other assets (two homes, 401(k) plan, stock portfolio, and real estate) only total about $6 million... too much ($15 million) for Sam, but not enough other assets (only $6 million) for Sam's siblings.

What to do?

We made each of the three kids equal one-third beneficiaries of the IDT. The trustee is instructed to keep the stock until both Joe and Mary are gone. Then a (properly drawn) buy/sell agreement kicks in. The IDT distributes the stock to the two nonbusiness kids, and the stock is immediately redeemed (bought by Success Co.) using the life insurance proceeds (on Joe and Mary) that funded the buy/sell. Note: If Joe dies first, the voting stock immediately goes to Sam so he can continue to run Success Co.

No. 3. Your Estate Plan

The wills and trusts for Joe and Mary were updated. Nothing fancy. Most important was that all aspects of these new documents dovetail with the other plans.

No. 4. Lifetime Planning is Key

The heart of any estate plan is always the lifetime plan. Why? Yes estate planning documents (typically your will and A/B trust) are essential, but they do nothing until you die. Sorry, but then it's too late to save estate taxes.

Life insurance is clearly part of your lifetime plan. Joe and Mary created an irrevocable life insurance, which purchased a large second-to-die policy.

Their lifetime plan also included: (a) a family limited partnership for their income real estate and stock portfolio; (b) a qualified personal residence trust for their two residences; (c) a 401(k) plan -- with a subtrust -- to help pay some of the required insurance premiums; (d) a new management company to give special fringe benefits to Joe and Sam as allowed by the tax law; and (e) an annual gifting program to the kids and grandkids to reduce their taxable estate.

Joe was amazed at how quick and easy it was to accomplish every one of his goals. Joe quipped, "I'm a LEG up now." One warning: all of the details of the above plans -- and possible tax traps if done wrong -- are not given. Only work with competent and experienced professionals.