Full disclosure: Preserving wealth planning can’t help any of us cheat death, but it can help business owners minimize taxes and achieve financial security.
The ideal Business Exit Plan includes a strategy to help you preserve your hard-earned wealth from unnecessary taxation when it is transferred to your family. However, for preserving wealth, business owners must take steps before they actually realize the wealth from their company. In other words, to realize all of the potential benefits of various wealth preservation techniques, owners must make plans before they convert the value of their businesses to cash.
The foundation for preserving wealth planning is found in answering the following questions:
Using your answers as guides, you and your advisors can choose the planning technique that will best preserve your wealth, provide for your family and minimize your tax bill. Let’s look at an example of how a business owner used wealth preservation techniques to do exactly that.
George recognized that he’d waited too long to begin gifting part of his company to his kids. A week earlier, George’s CPA told him that, based on the company’s pre-tax cash flow of $2 million per year, his company could be worth as much as $12 million to a third party.
After recovering from the shock of this realization, George understood that (a) he didn’t need nearly that much cash to retire in style and (b) if he didn’t transfer at least half the value of his business before selling, his family could be looking at millions in gift or estate taxes.
To remedy this situation, George and his Advisor did the following:
Through wealth preservation planning performed well in advance of his exit, George was able to:
George established these trusts when he created the GRAT to carry out his wishes regarding when (and whether) his children would receive money from those trusts.
Techniques such as GRATs and the careful use of minority discounts and other tax reduction techniques only work as intended if they are put in place well before you exit your business. These techniques also work well when two objectives-in this case, George’s financial security and his desire to provide for his family-must be achieved in tandem.
In this note, we provide additional details about how and why a GRAT can help achieve an owner’s twin objectives: financial security and providing for one’s family.
A GRAT is an irrevocable trust into which the business owner (and the trustee of the GRAT) transfers some of his or her stock. The GRAT must make a fixed payment (i.e., annuity) to the owner each year for a predetermined number of years. At the end of that period, any stock remaining is transferred to the owner’s children.
Stock transferred into a GRAT is treated as a gift. The amount of that gift is the value of the asset transferred minus the present value of the annuity that the owner will continue to receive. (George’s advisors made sure that the present value of the annuity paid out over four years almost equaled the value of the stock transferred into the GRAT. In doing so, George gave only a nominal and non-taxable gift.)
The key to a GRAT’s success is to transfer an asset that appreciates in value and/or produces income in excess of 120% of the federal midterm interest rate, which fluctuates monthly.
If you have questions, or need more information about death, taxes and preserving wealth, contact the skilled attorneys at Anthony J. Madonia & Associates, Ltd. today.
It would be our pleasure to discuss your business and estate planning needs.
For more information or to schedule an appointment, please complete the following, call or email us today.
We will respond within one business day.