In this edition

September 2024

Assets with Sentimental Value May Require More Thoughtful Planning Than Those with Greater Monetary Value

Transitioning Business Ownership: Tax-Smart Gift Strategies

Employee Feature: Amanda Farley

Three Ways to Sell Your Business to Employees, Children, or Other Insiders 

Making Will Revisions by Hand is Rarely a Good Idea

Welcome to Legacy Insights!

A Newsletter for Intentional Business and Wealth Planning

In today's complex financial landscape, decisions regarding business and personal wealth are more critical than ever. Our newsletter is designed to provide insights and best practices necessary to navigate business valuation, transactions, succession, and estate tax planning.

As businesses evolve and personal wealth accumulates, ensuring assets are managed and transferred effectively becomes paramount. Business valuation is essential for understanding the true value of a business and the net worth of an individual. Business valuations are used for retirement and management planning, preparing for purchase or sale, securing financing, or could be used for potential litigation. These life-changing situations require careful consideration and expert guidance to maximize value.

Succession planning is critical to maintaining a legacy. Whether planning for the next generation of leadership in a business or ensuring that wealth is preserved for future generations, having a solid strategy in place is vital. In addition, estate tax planning helps mitigate the tax burden on heirs, ensuring that more hard-earned wealth is effectively passed on.

Each month, Legacy Insights will deliver expert advice and actionable strategies to help you make informed decisions. We're here to support you in preserving and growing your legacy—both in business and life.

As a formal estate planning term, “tangible personal property” likely won’t elicit much emotion from you or your loved ones. However, the items that make up tangible personal property, such as jewelry, antiques, photographs and collectibles, may be the most difficult to plan for because of their significant sentimental value.

Without special planning on your part, squabbling among your family members over these items may lead to emotionally charged disputes and even litigation. Let’s look at a few steps you can take to ease any tensions surrounding these specific assets.

Communicate Clearly

There’s no reason to guess which personal items mean the most to your children and other family members. Create a dialogue to find out who wants what and to express your feelings about how you’d like to share your prized possessions.

Having these conversations can help you identify potential conflicts. After learning of any disputes, work out acceptable compromises during your lifetime.

Bequeath Assets to Specific Beneficiaries

Some people have their beneficiaries choose the items they want or authorize their executors to distribute personal property as they see fit. For some families, these approaches may work. But more often than not, they invite conflict.

Generally, the most effective strategy for avoiding costly disputes and litigation over personal property is to make specific bequests — in your will or revocable trust — to specific beneficiaries. For example, your will might leave your art collection to your son and your jewelry to your daughter.

Specific bequests are particularly important if you wish to leave personal property to a nonfamily member, such as a caregiver. The best way to avoid a challenge from family members on grounds of undue influence or lack of testamentary capacity is to express your wishes in a valid will executed when you’re “of sound mind.”

If you use a revocable trust (sometimes referred to as a “living” trust), you must transfer ownership of personal property to the trust to ensure that the property is distributed according to the trust’s terms. The trust controls only the property you put into it. It’s also a good idea to have a “pour-over” will, which provides that any property you own at your death is transferred to your trust. Keep in mind, however, that property that passes through your will and pours into your trust generally must go through probate.

Create a Personal Property Memorandum

Spelling out every gift of personal property in your will or trust can be cumbersome. If you wish to make many small gifts to several different relatives, your will or trust can get long in a hurry.

Plus, anytime you change your mind or decide to add another gift, you’ll have to amend your documents. Often, a more convenient solution is to prepare a personal property memorandum to provide instructions on the distribution of tangible personal property not listed in your will or trust.

In many states, a personal property memorandum is legally binding, provided it’s specifically referred to in your will and meets certain other requirements. You can change it or add to it at any time without the need to formally amend your will. Alternatively, you may want to give items to your loved ones while you’re still alive.

Plan for All Your Assets

Your major assets, such as real estate and business interests, are top of mind as you prepare your estate plan. But don’t forget to also plan for your tangible personal property. These lower-monetary-value assets may be more difficult to deal with, and more likely to cause disputes, than big-ticket items.

When it comes to selling your business, there are several routes you can take, including selling to a third party, gifting or selling to your children, or selling to a group of insiders such as co-owners and employees. Insiders, who are already familiar with the business, understand its culture, and share its long-term vision, often make ideal buyers. 

If selling to insiders seems like the best course for your business, the next step is deciding how to structure the sale. Here are three methods to consider, each designed to address the typical cash flow limitations of insiders. The best approach will depend on various factors, including tax consequences, risk, financing requirements, and your retirement timeline. 

....1. Sell, Bonus, or Gift Stock Over Time 

One way to transition ownership gradually is by selling, bonusing, or gifting shares of stock annually. This method typically involves transferring small interests in the company while the current owner retains control during the initial phase. The owner maintains a majority interest (greater than 50%) of the voting shares during this period. 

Once the owner is ready to relinquish control, the remaining shareholders and the company can buy out the majority interest. While this process may take longer and require more financial planning, it can be an effective way to transition ownership to company insiders. 

....2. Sell 100% of the Business in an Installment Sale 

An installment sale, as defined by the IRS, involves receiving at least one payment after the tax year in which the sale occurs. For instance, a seller might receive 10% of the purchase price per year over ten years, transferring a proportional number of shares to the buyer with each payment. 

Pros of an Installment Sale 

• Tax Benefits: The tax liability is spread over the installment period, rather than being recognized all at once. 
• Interest Income: The seller receives additional proceeds in the form of interest income on the balance owed. 
• Reduced Bank Debt Risk: Less bank debt is required, reducing the risk of default. 
• Higher Purchase Price: Buyers might be willing to pay more to incentivize the seller to accept installment payments. 
• Performance-Based Consideration: If tied to business performance, the seller may benefit from earnings growth during the installment period, which would be discounted in a lump sum payment. 

Cons of an Installment Sale 

• Seller’s Risk: The seller bears the risk if business performance declines. 
• Delayed Full Value: The seller might have to wait until the debt is paid off, which could take five to ten years. 
• Tax Rate Uncertainty: Future tax rate changes could result in a higher tax liability. 

....3. Stock Redemption 

In a stock redemption, the company buys out one or more shareholders, thereby increasing the ownership percentage of the remaining shareholders. For example, if you own 80% of the company and have two children who each own 10%, the company could buy your 80% interest, making your children 50/50 owners. 

Pros of Stock Redemption 

• Capital Gains Treatment: Proceeds are treated as capital gains, which are taxed at a lower rate than ordinary income. 
• Interest Deduction: Interest payments are reported as a deductible expense on the company's corporate return. 
• Easier Financing: The company can use its assets as collateral, making it easier to secure debt financing. 

Cons of Stock Redemption 

• Multiple Shareholders Needed: This method requires multiple shareholders; it doesn’t work if there is only one shareholder. 
• Detailed Tax Requirements: Certain tax requirements must be met, such as the seller having no interest other than as a creditor in some cases. 
• Possible Installment Structure: Depending on financing terms, proceeds to the seller may still be structured as an installment sale. 

Additional Options: Earn-Out Agreements 

An earn-out can manage risk for both buyers and sellers by tying part of the purchase price to the future performance of the business. For example, the purchase agreement could stipulate that if revenue grows by $1 million by a certain date, the sale price increases by $100,000. If the target is not met, the additional proceeds are not paid, effectively decreasing the purchase price. Earn-outs can be used in conjunction with the methods mentioned above to limit buyer risk while offering the seller potential for a higher price over time. 

Consult with Professionals to Start the Process 

If you are planning a transition and considering your options, the first step is to consult with professionals experienced in such transactions. They can help you understand your financial goals and objectives to find the best plan to meet your needs. Hawkins Ash CPAs has a team ready to help you. Reach out today! 

The experienced transaction specialists at Hawkins can assist you in determining which option is best for you and your business. 

Hawkins Ash CPAs

www.HawkinsAsh.CPA

info@ha.cpa