Succession Planning
Adding to our previous discussion on the recent Green Book proposals and their potential effects on your financial legacy, here we take a further look at the important aspect of succession planning. A well thought out plan for the succession of the management/ownership of any businesses you own should be established for eventual death or retirement. However, many business owners neglect to plan for succession. Simply relying on the state inheritance laws to determine the future of your business is an invite for the demise of your hard work. How might you approach this subject?
The first step of an effective business succession plan is to define goals which should factor in the owner’s needs in retirement and as they age. Determine who to include in the succession plan. Think through the logistics of the succession plan, starting with who should be involved. Don’t ignore key employees. To help determine who should be part of the succession plan, ask yourself these planning questions:
Who are my heirs?
If I have multiple heirs, what is the split between those who are businesspeople and non-businesspeople?
If there are multiple heirs who want to manage a business, would they be able to do it successfully and be able to work well together?
How might increasing the number of heirs affect my business’s succession plan?
Once you’ve answered these questions, you can start to answer the question of who might do what in the future of your operation. You may start letting your heirs manage the simpler, more established parts of your business. If there are revenue streams which are essential to your retirement plan, don’t feel pressured to release them within your lifetime.
As you map out your succession plan goals, good communication is required. How does that get accomplished? Set up meetings with structure. The length of the meetings and participants should vary depending on what needs to be discussed. The meetings should have a facilitator/leader, a self-explanatory agenda, and notes should be taken. It is recommended that an outside advisor with relevant business experience be used as a facilitator.
It is very important that all appropriate members should be in attendance as meetings progress first starting with all current owners. They are the ones that have the authority to make the decision, but others should also be included when appropriate:
Members that are impacted by the decision both family and key employees
Members that understand the ag issue(s), include other outside advisors when appropriate, attorneys, insurance agents, real estate agents and tax advisors
Members that must act on the decision (a person(s) should be identified as being responsible for the required action)
Succession planning should address any change in upper management. Meetings should be focused on the process of transitioning management and/or ownership of a family business from one generation to the next. Assets may be involved which have high value but low liquidity, like real estate. Unfortunately, greed may set in with non-active family members so good early communication of the succession plan should be made with all that are impacted.
As mentioned, often it is best to retain as much of the business as you can in one unit. This can be accomplished by passing down assets like rental properties, gas and mineral rights, and retirement accounts to non-business heirs, while passing down the productive assets to the business heirs. This approach may help you avoid family disputes by providing a more equitable outcome for all heirs.
It is a common myth that the only way to fairly pass on your farm or ranch is to equally distribute equity/asset ownership among heirs. In some cases, this could reduce overall value. If you do decide to split things, carefully consider whether this might cause fractures and limit the long-term viability of the business and reduce the likelihood that the businesses will stay within the family.
Machinery provides several options for succession planning. It can be sold outright or in installments, or ownership can be transferred as machinery is replaced. Each option has tax implications, so you’ll want to consult with your tax advisor. Gifting machinery may help limit some income tax consequences but could also result in a gift tax. Finally, machinery can be leased to your successor, but you will have to determine beforehand who will pay for repairs.
Consider the timing and method of transfer ownership of your land. Land can be transferred during your lifetime by sale or gift, or upon your death. Sales may take place through cash or installments. Gifting your land to your heirs can help with gift taxes, especially if you’re dividing it among several people. You, if married, can give up to $30,000 of property each year to as many people as you’d like without paying gift tax. However, gifting a property means that you are also giving up ownership rights to that property. This means you may end up paying rent to your heirs. Transferring land upon death is the most common approach. It allows you to use the property and receive income from it through retirement. Tax laws vary regarding inheritance. Consulting with a tax professional is an important step before making land transfer decisions.
Using life insurance for business succession planning can play an important role. However, it is important to take care of this step early in the process. You should know the following about using life insurance for business succession planning:
Payments for life insurance should typically come from one or more of the heirs. In most cases, this will keep the insurance proceeds outside of the taxable estate.
Life insurance can also be a useful tool for the ranching heir to buy out non- ranching heirs.
Your health, the number of heirs, the size of your estate, the ranch location, where you live, and many other factors play a role in this decision. Consult with an insurance agent and other succession planners to see if this is a good option.
The new administration has proposed reducing the estate and gift tax exemption amount from $11.7 million to $3.5 million. This is one of his revenue raisers. For example, an estate of $5 million which is currently under the $11.7 million limit would be taxable for amounts over $3.5 million or approximately $546 thousand in tax ($5 million, minus $3.5 million, times current estate rate). Annual gifting is one strategy to consider to help reduce the impact of any decrease in estate exemption. While gifting above annual limits will necessitate a gift tax return, no tax will be owed as long as amounts are under the lifetime exemption limit. It is possible to use the full exemption limit ($11.7 million) even if it is latter lowered to $3.5 million. The IRS has confirmed that it will not claw back tax on lifetime gifts if the exemption is subsequently lowered. (IR-2019-189). But, laws can change.
Summary
By taking a look at your assets long before you’re ready to transfer ownership of your business, you are giving yourself time to choose the best path for you and your family. The transfer of a working business to the next generation may not always seem fair and equitable when multiple heirs are present. You must decide what the sweat equity required to maintain the business operation is worth. You may provide additional resources to that heir as an incentive for them to provide that sweat equity. Succession planning should include an attorney, an insurance agent and an accountant/tax advisor that are experienced in the relevant business/asset class. With the focus of the new administration on raising tax revenue from wealthy taxpayers, estate planning is more important than ever. If your estate might be impacted by the lower proposed exemption limit, gifting under the current exemption might save some tax. But, any gifting should make long-term economic sense. Your tax advisor should be of help in the review of your succession plans to help preserve your legacy.