Taxes are probably the greatest impediment to growing wealth. This is particularly true for the family business. There is no one-size-fits-all solution for tax planning. Your situation is uniquely your own, shaped by your specific goals, needs and limitations.
Yet when a high-income individual or family meets with a tax attorney to plan for their future, they often have a similar experience. The lawyer immediately throws out alphabet soup recommendations, from CLTs (charitable lead trusts) and GRATs (grantor retained annuity trusts) to DSTs (deferred sales trusts) and CRTs (charitable remainder trusts), before fully understanding their clients’ desires. The firm may have an interest in marketing specific products that they sell, which may also come with hidden costs and fine print.
You deserve custom tax solutions aligned with your personal circumstances and needs. Based on my expertise in tax planning and estate planning, here are six practical tips to help you weigh your options and craft the right plan for you and your loved ones.
1. Identify both your financial and personal goals.
You can’t create a road map unless you know your ultimate destination. Take the time to outline your financial and nonfinancial or personal goals. Start with the basics, then delve deeper into the details.
If you want to sell your business and retire, you likely want to reduce your tax liability, but don’t stop there. What are your retirement goals? What are your cash flow needs to maintain your lifestyle? What are your family’s financial needs? What do you want to do with your money when you retire? Getting clear on both your dreams and your requirements is an essential first step in planning for the future.
2. Plan early.
The best time to start tax planning is two or three years before a major event, such as a business sale or retirement, because many of the most advantageous strategies to enhance the value of the business require a bit of lead time. For example, the two-year installment sale must be fully implemented at least two years and one day before the sale of the appreciated business or capital asset closes. Once implemented, the taxable capital gain is deferred for 20 or more years.
People often come to see me when they already have a buyer set up or an exit date in mind, but in my experience, giving yourself a longer runway minimizes stress and maximizes outcomes. You may be able to take steps to enhance or increase the value or purchase price of the business or assets to be sold. Also, as discussed below, the tax savings plan must be fully implemented before there is a binding agreement to sell. If not, the plan may be disallowed as an arbitrary assignment of income.
3. Consider your retirement plan details.
As you approach the exit for your business or retirement, consider how your plan will affect you and the people closest to you. Are you truly ready for retirement? What do you want the next chapter of your life to look like? When you run a business, you often have access to certain perks, such as a company car, club memberships or company payment of entertainment or other expenses. Are you prepared to give up these extras when you sell the business?
Your retirement will also impact your employees and family. In a business sale or transition, there are three main groups of potential buyers: family members, key employees or outside investors. Before making a decision, carefully consider the advantages and disadvantages of selling to each group and how these factors may affect the sale price and terms, as well as your relationships and the continued success of the business after the sale.
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4. Work with a specialist.
Do your research to find a tax planning firm that is suited to your individual needs. Look for a firm that has certified specialists in the areas most important to you, such as estate planning and taxation. Even among tax professionals, there is a great deal of variation. CPAs, for example, are experts on tax reporting but may not have the tax planning experience you seek. You need a tax professional familiar with recommending steps to materially reduce income and not just file a tax return. I recommend vetting lawyers and law firms on the Martindale-Hubbell directory. You can search for legal professionals in your area, assessing their credentials, certifications and practice areas and reading reviews from both their clients and industry peers.
5. Explore different tax strategies or opportunities.
Tax strategies are as diverse as the situations they cater to. I estimate that there are 50 or more tools available, and the best approach depends on your particular concerns, demands and desires. Be transparent with your tax attorney about what you want and work with them to create a customized, comprehensive solution.
For instance, in an asset sale of a general or C corporation, goodwill — an intangible asset that represents the value the business can offer a buyer — is typically viewed and taxed as either "company/enterprise goodwill" or as "personal goodwill." Since personal goodwill usually refers to the contributions of the business owner as an individual, you may achieve substantial savings. For a C corporation, which is subject to tax at both the corporate and individual levels, the characterization as personal goodwill entirely avoids the corporate level of tax for the amount allocated to personal goodwill.
For the stock sale of an S corporation, a corporation with limited shareholders, you can allocate a portion of your personal goodwill to a charitable structure — such as a split interest income trust — to provide an income deduction tax and ongoing income for you and your family after the sale. Such an allocation would not otherwise be possible due to the restrictions on who is a permissible shareholder in an S corporation.
Other tax-saving strategies include basis shifting for the sale of appreciated assets from LLCs or partnerships, opportunity zone funds created solely for you and your family and structured sales to defer taxable gains. Even your estate plan can be used to dramatically reduce income tax with the upstream basis trust or the optimal basis and income tax efficiency trust.
6. Plan timing and formalities carefully.
Tax planning is very unforgiving. A tax plan typically must be implemented before the sale of an appreciated asset is binding. Failure to do so may cause an otherwise perfect plan to fail, resulting in tax, interest and even penalties. You must also strictly follow all of the formalities of your plan. You must dot the i’s and cross the t’s or put your entire plan at risk.
Tax planning is a multifaceted process that requires a personalized approach, especially for high-income individuals and families. By implementing these strategies, you can more easily navigate these complexities and make informed decisions that reduce your tax liability, support your retirement goals and create a sustainable financial future for you and your family.
