What are some important pre-sale considerations for business owners?By Bill Loftus
“The three pillars of an effective wealth planning strategy are the timing of the valuation, the timing of the gift and discounting.”
When a business is up for sale, closing the deal is often the top priority for the owner—understandably so, because for many owners, the business itself represents the largest asset on his or her personal balance sheet. While closing the deal is important, as owner, you should also consider how this sale will affect your family’s financial scenario. Important considerations include tax-planning opportunities which, if ignored, might result in significant lost income, gift and estate tax savings.
The three pillars of an effective wealth planning strategy are the tim- ing of the valuation, the timing of the gift and discounting. These pillars, combined with effective tax planning strategies and appropriate gifting techniques, will ensure that money is not left on the table during a sale.
For many owners, the valuation of a business obtained in advance of a sale may be significantly less than the ultimate sale price. Since estate and gift taxes are based on the fair market value of assets at the time of transfer, owners should take advantage of lower valuations, to shift wealth to family members at a lower cost.
The crux of any pre-sale planning is the appraisal. Appraisals of closely held business interests take into consideration discounts for lack of marketability and control. However, once a business is sold to an unrelated third party, the opportunity to apply a discount to the sale price is no longer available. Therefore, have the appraisal done as early as possible in the process.
Transfers should be completed as far in advance of the sale as possible. The closer the transfer occurs to the sale, the more likely it is that the IRS will successfully argue that the sale price reflects fair market value at the time of the gift. There is no concrete test the IRS has provided. But it is important to look at factors that deter- mine the certainty of the sale taking place, to discern whether the valuation is accurate.
Court cases reveal that the valuation of closely held entities is a judgment call that relies upon expert opinion. Courts and the IRS have recognized discounts for lack of marketability and lack of control. However, though no clear test has been established; specific circumstances are examined in each case. Discounts for lack of marketability and lack of control range from 13 percent to 59 percent, according to studies, and courts have accepted discounts in this range under different circumstances.
Tax Planning Strategies–Residency
Business owners in high-income-tax states sometimes change their residency for income tax purposes prior to a sale to avoid state income tax. New York, New Jersey, and California have some of the highest tax rates; no-income-tax states include Florida, Nevada and Washington. The requirements to establish a new domicile for income tax purposes are state specific, tedious and complex, so consult state-specific counsel.
There are also numerous planning strategies to transfer wealth using discounts that range from intention- ally defective grantor trusts to family limited partnerships. The benefits include not only shifting the present value of the shares out of your taxable estate but also future growth. Deter- mining which strategy—valuation, timing or discounting—is optimal for you requires thoroughly understand- ing your family’s current financial landscape and goals.
We can help you utilize the gifting strategy that best fits your needs and maximizes the sale of your business. Benjamin Franklin once wrote, “Nothing is certain but death and taxes,” and he was right. But another certainty is that by actively engaging in pre- sale planning before you sell your business, you can increase the odds that you will have a successful exit.