Financial Foresight For A Smooth Succession

Financial Foresight For A Smooth Succession

An effective succession plan provides a smooth transition in management and ownership with a minimum of financial hassle.

This article was written by Mark Battersby

A succession plan for the business can help ensure that a closely-held or family repair shop, however big or small, will continue to operate successfully when the owner or owners exit, retire, pass away or are suddenly incapacitated.

Successfully Planning Succession

A succession plan is, in essence, a blueprint should there be a changing of the guard – which is inevitable sooner or later. Succession planning takes time and should not happen all at once. Generally, there are a number of transition strategies that should be addressed in a good succession plan including:

• Founder transition. How long does the owner plan to stay involved in the repair business, what are his or her retirement plans, if any?

• Family Transition: If the plan is to leave the business to family members, how will roles and power relationships change? How will family harmony be maintained through the transition?

• Business Transition: How will business operations and customer relations be impacted or maintained through the transition?

• Management Transition: Will management consist of family, non-family or both? How will the operation’s new leadership be evaluated and on what schedule will control of day-to-day decisions be transferred?

• Ownership Transition: How will ownership be transferred? A sale to management? A sale to employees? A sale to a third-party? A sale or gift to children?

The ESOP Option

Succession planning offers a number of options for transitioning the shop for continued operations and minimal taxes for both the departing owner and the business. One option involves selling the business to its employees.

An Employee Stock Ownership Plan or ESOP is an employee benefit plan that gives workers an ownership interest in the shop, in the form of shares of stock. About two-thirds of ESOPs are used to provide a market for the shares of a departing owner’s closely held businesses. Many of the remainder are used either as a supplemental employee benefit plan or as a means to borrow money in a tax-favored manner.

Options For Keeping The Family Business In The Family

By controlling the shop through a “family limited partnership” or FLP, owners get the added benefit of gifting shares at considerable discounts. A FLP can also assist in transferring a business interest to family members.

First, a partnership with both general and limited partnership interests is created. Then, the business is transferred to this partnership. A general partnership interest is retained for the owner, allowing a continuation of control over the day-to-day operation of the business. Over time, the limited partnership interest is gifted to family members.

Some succession plans involve outright gifts, rather than selling or transferring an interest in the repair shop. Outright gifting is usually limited to business owners who do not need the proceeds from selling their interest in the shop.

An outright gift is the least complex, but most inefficient way to transfer wealth. A small annual gift $18,000 for individuals in 2024, $36,000 for married couples, can be made to multiple parties without affecting lifetime exclusions necessary to avoid paying estate taxes.

Obviously, any automotive service or repair business with significant value would require years to give away. Fortunately, shop owners can use their lifetime exclusions which in 2024 amounts to $13.61 million or #27.22 million for married couples with no gift tax bill.

The so-called generation-skipping transfer (GST) tax is an additional tax on a transfer of title to a property that skips a generation. Created to prevent families from avoiding the estate tax for one or more generations by making gifts or bequests directly to grandchildren or great-grandchildren rather than to their children, the same exclusions apply before the GST tax kicks in.

Successful Selling Strategies

Selling the shop outright remains an option although one with many potential stumbling blocks -– and a number of tax consequences. Among the strategies for a business sale are buy-sell agreements.

The buy-sell agreement is a legally binding agreement that requires one party to sell and another party to buy a particular ownership interest in a business at the occurrence of a triggering event, such as the death or disability of an owner. In other words, a buy-sell agreement can be designed to protect the repair shop from certain triggering events, events that might otherwise create significant turmoil.

A buy-sell agreement usually stipulates how much will be paid to the seller’s estate, heirs or to the business itself should the triggering event occur along with the specific method to determine the value of the business at the time the event occurs.

Instead of a sale with a buy-sell agreement, a regular sale of a shop business can be structured to substantially reduce the tax bite. Tax savings usually result when the owner transfers an interest in the business in exchange for a promissory note. So long as the note includes interest payments at the applicable federal rate, specifies the assets or interest being sold and is conducted at “arms-length” with a non-related party, it qualifies as an installment sale.

Installment sales allow the profits resulting from the sale to be repotted -– and subjected to the capital gain tax -– as each percentage of the sale price is received each year. Naturally, the buyer must demonstrate that the funds are available to complete this transaction with the seller having an option to recover the interest in the business should a default occur.

An Option Of Trust

An increasingly common question in both estate tax and succession planning is should the business be owned in a trust? Not so surprisingly, there are many answers to this question with every situation different. Among the consideration when evaluating the benefits of having a trust own a portion of the equity in the automotive service or repair business – and the potential pitfalls are:

* CONTROL. Transferring a portion of the equity of the business ensures the family will continue to own the business even if non-family members run it. Often an owner will transfer the non-voting interest to a trust and maintain control by keeping the voting interest in his or her name

* CONTINUING CASH FLOW. A common concern with business succession planning is providing cash flow to a surviving spouse. Having a trust own a portion of the shop can help address this.

* ASSET PROTECTION. Assets gifted to a trust are no longer owned by the business owner and may be protected from his or her potential creditors. Going one step further, assets left to children in trust rather than outright may be protected from the child’s potential credits.

* ESTATE TAXES. Yes, estate taxes. Even though a separate consideration, the business owner may make a gift of a non-voting interest in the business to a trust for the benefit of his or her family, the gift removes the asset’s value from the owner’s taxable estate. All future appreciation in the value of the shop may also be removed from the owner’s estate and may, in fact, see the actual value of the gift discounted due to a lack of control and a lack of marketability.

* INCOME TAXES. A trust is often used as an income tax planning tool. Much like a Family Limited Partnership, trust income is distributed among the shop owner’s children, the income may be taxed at lower tax rates. Trusts may also be structured in a manner that produces tax savings on the state level.

Other Options

Obviously, there are many other options the owner of a repair shop might consider with all being dependent on what the owner expects, desires or hopes to achieve. A merger is one such option since joining with a competitor or related business ensures the businesses survival and growth.

On the same path, a repair shop that is acquired by another may not produce the results desired by the acquired business’s owner. An option such as an outright sale of the business usually results in the seller cutting all ties to his or her business. Being acquired, on the other hand might mean continued involvement with the operation with severance occurring down the road.

Get Pro Help

An effectively developed succession plan provides a smooth transition in management and ownership with a minimum of transfer taxes. Succession planning is obviously critical to ensuring the continuation of any family-owned automotive repair business. An effectively developed succession plan provides a smooth transition in management and ownership with a minimum tax bite.

Succession planning is a contingency plan and not a one-time event. Rather it should be evaluated and updated as changes dictate within the shop. However, given the number and complexity of transitions and succession options available, effective succession planning requires time, and the assistance of outside advisers.

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