Thinking about the future of your business is important—whether you’re planning to retire, step back, or just want a safety net in case something unexpected happens. Having a solid succession plan helps protect what you’ve built and ensures a smooth transition. Here are five options to consider, along with key tax implications.
1. Passing your business to family
Many small business owners want to keep their company in the family. You can do this by selling it to a family member, gifting it, or a mix of both.
Tax considerations:
- Gift tax: If you give part of the business as a gift, the IRS may apply a gift tax. The good news? You can gift up to $19,000 per person (as of 2024) without tax concerns. Plus, larger gifts may be covered under your lifetime exemption.
- Estate planning: If you pass away before transferring ownership, your business could be subject to estate taxes. Proper planning, like setting up a trust, can help reduce this burden.
- Capital gains tax: Selling to a family member for less than fair market value could lead to capital gains tax when they sell it in the future.
2. Using a trust for ownership transfer
A trust allows you to transfer your business while maintaining control over how it’s managed. This can be a good option if you want to keep the business in the family but set specific terms for its future.
Tax considerations:
- Minimizes estate taxes: A well-structured trust can help reduce estate and gift taxes.
- Legal complexity: Trusts have strict rules, so you’ll need a tax advisor and an attorney to ensure everything is set up correctly.
3. Selling to employees or management
Your employees already know the business, so selling to them can provide a seamless transition. Many times, employees don’t have the cash to buy it outright, so this often involves installment payments or seller financing.
Tax considerations:
- Spread-out payments: Selling in installments can spread out your tax burden over time, reducing the chances of hitting a higher tax bracket.
- Interest taxation: If you finance the sale, any interest earned on payments is taxable income.
4. Setting up an Employee Stock Ownership Plan (ESOP)
An ESOP allows employees to become part-owners by receiving company shares through a retirement plan. This can be a great way to reward and retain your team.
Tax considerations:
- Owner benefits: If your company is a C corporation, selling to an ESOP may allow you to defer capital gains tax.
- Tax deductions: Your business can deduct contributions to the ESOP, reducing taxable income.
5. Selling to an outside buyer
Sometimes, the best option is selling to someone outside the company—like a competitor, investor, or private equity firm. This can often bring in the highest sale price.
Tax considerations:
- Capital gains tax: If you sell for more than your original investment in the business, you’ll owe capital gains tax. Owning the business for over a year typically qualifies you for lower long-term capital gains rates.
- Purchase price allocation: If selling assets, how you and the buyer divide the sale price among equipment, property, and intangible assets will impact both parties’ taxes.
Choosing the right path
Every business transition is unique, and the best choice depends on your personal goals, financial needs, and who you want to take over. A solid succession plan helps ensure a smooth transition while keeping taxes in check. If you’re considering your options, talk to your local Padgett advisor or attorney to make sure your plan works in your favor.