There may come a point when a business owner will want to turn over their business to one of their family members. This could be due to a variety of reasons. Perhaps they are going to retire and wish to entrust their business with a family member who they know will run it well. Either that or the business owner may just want to sell their business to a family member or give it to them as a gift. Whatever the reason is, it is important to understand how to transfer your business to your son or daughter so you incur the least amount debt and tax liability possible.
Related Legal Documents to Download:
- Business Gift Agreement Template (Sole Proprietor)
- Business Gift Agreement Template (LLC or Corporation)
- Full Package of Transfer Documents
Furthermore, you must consider how much money you want to take away from the business transfer so that you can afford to move on with the next chapter of your life. The decision you make will likely revolve around how much your business is truly worth. Are you transferring your business to escape liability or to cash out and retire? How much liability are you placing on the shoulders of the family member who is taking over your business? This is what will be discussed below.
Clarify Your Retirement Income Needs
If you are transferring your business for the purpose of retirement, then you will obviously want to sell the business to them rather than just give it away. After all, you need to have a substantial amount of income or money in the bank that you can use to afford your lifestyle and living expenses after you retire. So, what you must figure out is how much money you will need in order to live in retirement for the next 20, 30, or 40 years. All this money won’t necessary come from just the sale of your business. Perhaps you have other investments, assets, or businesses that you could draw money from too.
But what you will need is enough money to at least afford the lifestyle that you are currently living. This means accounting for expenses like car premiums, health insurance premiums, mortgages, food, utilities, clothes, club memberships, vacations, and so on. Fortunately, most retirees already have their home paid for so you may not have a mortgage to worry about. This means your retirement expenses will be significantly less than your previous lifestyle expenses.
Video: Transferring a business to inside family members is fraught with drama and many times inequalities among non-working siblings. Working through the relationships connected to the business transfer is harder than designing the buyout. Business succession expert Nate Sachs addresses the topic.
There are two ways you can receive income from the sale of your business to you son, daughter or any other family member. You could either take a one lump sum of the entire amount or you can stay partially connected to the business and earn a monthly income from it. A lot of times, owners will continue serving on the board of directors or will stay as a paid consultant to the new owner. If you still want to play a more important role, you can continue helping clients and keep the business operations afloat until the new owner gets used to how the business is run. You may want to do this in order to ensure the success of the new owner. After all, if your son or daughter fails at running the business and you are expecting to receive monthly payments from him/her, these payments will stop showing up and that will interfere with your retirement. So, you’ll want to stick around and help make sure this does not happen.
As for owners who don’t want to play such an important role in the business after it is sold, they can just keep ownership of the physical assets and then lease them out to the new owner. If you happen to own the commercial building where the business is run from, you could collect money from the lease every month and not have to lift a finger in operating the business. Therefore, just figure out how much you want to serve in the company and which option will give you the income that you need to enjoy the retirement lifestyle that you want to have.
Options for Transfer
The three main ways in which a business can be transferred to a family member is as a gift, through a sale, or through a partial sale. You might think that a sale would always be the obvious choice because you can make money that way. However, there are times when giving the business away as a gift might be the better choice. Perhaps the business has a lot of debt or taxes owed and you don’t have the time or energy to try and turn it around. So, you pass the responsibility to one of your family members and let them deal with it. Don’t worry about the gift taxes either because you can take advantage of the $5.45 million lifetime exemption that the U.S. Congress passed towards gift taxes. The giver would normally have to pay taxes on their gifts but now they can wait until the total value of their gifts has reached $5.45 million before having to pay taxes. This means if your business is worth less than $5.45 million, you could give away the whole thing and not pay any gift taxes. Furthermore, you won’t be subjected to any capital gains taxes or estate taxes after the transfer is completed because you will no longer own the company. If you only want to give part of your company away as a gift, you can do that too but then you will have some liability with captain gains and estate taxes.
The second transfer option is to sell your business to your family member either in full or partially. Chances are that your family member is not going to have the cash to purchase your business in full so you will have to seller finance most of the sales price for them. They could try going to a bank and getting a loan, but most banks do not like giving loans to people so they can purchase other businesses unless they have an excellent commercial credit history. Therefore, you will have to conduct a note sale where the buyer agrees to make payments to you every month in exchange for getting ownership of the company. These payments are applied to the principal amount that was seller financed with added interest on top of it. If for some reason the buyer defaults, then you would legally be able to get the business back while keeping all the payments that were made up until that point. The only thing is you must hope that the business itself has not been ruined by the previous family member who was running it while you were away.
Thirdly, you can conduct a partial sale where you only transfer certain portions of your business and its assets. This will give you the flexibility to still have some say in how the company is run and it will allow you to continue getting a steady income from leasing the assets and building to the new owner. The only downside is that your profits from the partial sale will be subjected to a captain gains tax but this should be expected from all business sales where profits are made. But the upside to a partial sale is that you can cash out and still receive a steady income at the same time. Meanwhile, the new owner is running the company and you don’t have to make any of the important decisions or spend too much time dealing with its operation.
Question: What form do I use to transfer my small business in Texas to my daughter?
This is a very common problem and concern among business owners. Some thought and preparation is required to transfer a business to a family member because there are tax considerations as well as other legal obstacles.
The Business Gift Agreement is typically used when you would like to turn over control of your business to someone else, usually your child or other family member when you’re ready to retire.
Some solutions depend on the timing of the transfer (now, or upon death), and whether there are other shareholders, etc. If the need is immediate you could use a simple Business Sale Agreement where the owner's shares are transferred to the family member but there would be tax consequences (to the extent the purchase price is below fair market value the purchaser would be imputed income and therefore incur tax liability).
If the need is to transfer upon death, the simplest way is with the Buy/Sell Agreement (if you look there's an option to transfer a business to a single individual that's typically funded via insurance).
The owner could also transfer their shares of the business into a trust and ownership would automatically transfer to the beneficiaries of the trust at the death of the owner. Depending on the value of the business a certain portion would be shielded from taxes.
Now that you know all the ways you can transfer your business interests, the next thing you must learn is the methods of implementing these transfers. A buy-sell agreement is the most basic legal agreement for transferring business interests in a company. You can use a buy-sell agreement to sell your business right away for its full asking price or you can use it to transfer your business interests at a later date. For example, if you want to transfer your business interests to a family member when you die, become disabled or retire, you can put these specifications in the buy-sell agreement and both you and the buyer will have to abide by them. Then when the event specified in the agreement presents itself, the buyer has an obligation to pay the amount that was agreed to in the buy-sell agreement.
If you are in a situation where the family member would rather make payments to you instead of paying the whole sales price upfront, then you can setup a private annuity agreement. This is a special sale where you transfer ownership of the business to the buyer and they agree to pay you payments periodically for the rest of your life. Those who want to retire may find private annuities beneficial if they cannot get full cash from their family member for the business. However, private annuities have no security behind them so you have to truly trust the family member that you are arranging this with. That is why a self-canceling installment note may be better to use because they give the seller added security when the transfer their business over. The buyer would basically agree to the same terms as they would in a private annuity agreement. They would make payments to the seller for the rest of their life in exchange for getting ownership of the business. But when the seller dies, all the remaining payments that were owed to them get canceled. No one will even have to pay estate or gift taxes either.
Strategies to Minimize Taxes
When you are in the process of transferring your business over to a family member, you will want to implement certain strategies that will help you minimize your tax burden. We’ve already discussed how there is a lifetime gift tax exemption of $5.45 million that business owners can take advantage of when they give their business away as a gift. However, there may be some owners who go over this tax exemption limit and will still want to minimize their gift taxes as much as possible. Fortunately, the Internal Revenue Service has declared there to be an annual gift tax exemption of $14,000. This means you can give up to $14,000 per year to one or more people and not have to pay any gift taxes. This $14,000 can also be counted towards any portion of your business that you give away to a family member.
Let’s say you wanted to construct a systematic gift giving program with your family members for the purpose of giving away your business interests to them without incurring much gift tax liability. What you could do is give $14,000 worth of business interests to each of your family members per year until the business interests have all been transferred. This systematic gift giving program basically allows you to transfer large portions of your business without having any gift tax liability whatsoever. Of course, the downside here is that you have to wait for a number of years before the transfer of the business is complete. But if you are only trying to transfer a portion of your business and not the whole thing, this systematic approach may be your best option for avoiding gift taxes.
If you want until your death before giving your business away as a gift, the Internal Revenue Service has special rules available for estate taxes. Normally, the heirs of a deceased business owner would have to pay an estate tax rate of up to 40% before they can take over ownership interests in the company. But the Internal Revenue Service allows the estate taxes of a closely held business, such as a family business, to have a 5-year deferment. This means that the heirs only have to make payments on the interest during the first 4 years of the deferment and then pay the interest and principal on the 5th year. Annual installments can be paid toward the principal over a 10-year period after that. This is a great benefit for the heirs because it gives them time to raise money and seek out better interest rates so they can pay off the estate taxes and claim their interests in the business. The only stipulation is that the business must be worth more than 35% of the owner’s gross estate. Other requirements also must be met too.