Business foundersStrategies for keeping the family business in the family

Having a plan for how your family business will continue once you no longer serve in a leadership capacity is an important consideration for business owners. If family members are part of the operation – particularly your children or grandchildren – your intent may be to pass ownership of the business to them.

While your perception may be that leaving the business to family simplifies the process of transitioning to new ownership, the reality is it can be quite complex. Keeping family harmony throughout the process should be a priority. In addition, the tax implications can be significant if handled incorrectly. It’s important to get all the details right so the ownership transfers smoothly and correctly.

Communication is critical to a successful family business transition

You may believe your plans to shift the business to children or other family members in the future is in line with their own expectations. Yet you shouldn’t assume that you and your intended heirs are on the same page. “The key to a successful transition is a communications strategy,” says Scott Mahon, senior vice president of wealth strategy for Ascent Private Capital Management of U.S. Bank. “Owners should express their intentions, and other family members should indicate if they are on board with the transition strategy.”

You also need to make sure that the family members you designate for leadership roles are up to the task. “We always use three years as a benchmark for the lead time needed to fully execute a business transfer,” says Mahon. “Family dynamics and the preparedness of specific family members to step up into new roles will dictate whether that is sufficient time to finalize the arrangement.”

Mahon adds that owners should be clear about their role and intentions to step down. “Sometimes, owners who say they are phasing out of the business continue in a leadership role, which can be demoralizing for the successors. It can undermine the efforts of the new leadership team.”

Using a gifting strategy to transfer your family business

When it comes to making a tax-efficient transfer, you should think about completing the process while you’re still alive. Depending on the size of the business, estate tax can become a significant burden for beneficiaries if the business passes on after your death.

Owners of smaller companies can gift the business over a period of years using the annual gift tax exclusion, or zeroed out GRAT, to avoid tax consequences ($17,000 for individuals/$34,000 for married couples filing jointly in 2023). Those with larger businesses who want to gift it to family members should consider doing so now, while the lifetime unified estate and gift tax exemption is at its highest ($12.92 million for individuals/$25.84 million for married couples filing jointly in 2023). Under current law, the exclusion amount will revert to approximately half that total in 2026. To the extent the business has value above the exemption level, a 40% estate tax rate applies.

“If a family is subject to that tax, it can create liquidity issues,” says Mahon. “To cover the estate tax burden, beneficiaries can be forced to sell some assets to generate the required liquidity.” Typically, beneficiaries have nine months to settle estate tax liabilities and the IRS only accepts cash.

“If you want to keep the business in the family, you need a plan for that. It may require a number of family meetings to discuss who is being positioned to take over the company and what role, if any, there will be for other family members.”

- Scott Mahon, Ascent Private Capital Management

If you intend to maintain ownership until death, life insurance proceeds can help your heirs meet the potential tax obligations. However, you’ll have greater flexibility if you choose to transfer the business prior to your passing.

Transitioning your business through a trust

Another transition option to consider is selling or gifting your business to a trust. It removes the business from your estate, reducing or eliminating future estate tax liabilities associated with the business and helping you transfer it to family members in a tax-efficient manner.

Common techniques include a gift using a grantor retained annuity trust (GRAT) and a sale to intentionally defective grantor trusts (IDGT). Other trust strategies may be appropriate as well. You’ll want to consult with your estate planning professionals to explore all the options that may be most effective for you.

Utilizing intra-family lending as part of your transition plan

Low interest loans may be used to transfer family business interests to your family members in a tax-efficient manner. This approach can be useful in situations where the value of the business exceeds the current unified estate and gift tax exemption.

Intra-family loans can help family members purchase shares of the family business and offer the following flexibility:

• The terms can be determined by the parties involved in the loan.
• The loan can be designed to be secured or unsecured.
• Payments can be for interest only or using an amortization schedule.
• The loan can finance the acquisition, provide working capital or a combination of the two.
• Reporting and oversight standards for the loan can be established by agreement of the parties.

Intra-family loans typically use the Applicable Federal Rate as the interest rate charged on the loan. If the rate is lower than that, the loan is considered a gift. The Applicable Federal Rate varies based on the term (length) of the loan and the lender has the right to charge an interest rate in excess of the federal rate. It’s important that the borrower is confident that the business can generate a sufficient stream of income to allow for timely repayment of the loan.

Prioritizing the family

Emotions can run high in family financial discussions. It’s important to focus on developing good communication and seek family consensus on how the transfer will proceed.

“If you want to keep the business in the family, you need a plan for that,” says Mahon. “This may require a communications plan and family meetings to discuss who is being positioned to take over the company and what role, if any, there will be for other family members.”

Professional support, from valuing the business to setting up a gifting strategy (if appropriate) is critical. Learn how Ascent Private Capital Management works with advisors and other professionals to help business owners and founders through business transitions.