Forward Pass

When it comes to transferring wealth, the best defense is a good offense.

Charles W. Mahan, Esq.

October 1, 2007

Successfully transferring wealth is all about strategy. Business owners must plan for this change and prepare everyone involved—including family, business partners, and a team of professionals like an accountant and attorney—to do their part and know exactly what to expect. Like any major business move, this one can be daunting. But with a solid game plan in place, transferring wealth can turn into a winning proposition.

A wealth transfer is the orderly transition of ownership of the assets one has accumulated in his or her name into the name of a third party, when and in the manner chosen by the first party. In other (simpler) words, it is when a person gives some or all of the control of his or her assets to someone else. This may mean giving control to a buyer of a business; to the trustee of a living trust; or to a spouse, children, or other heirs. One might share a portion of those assets with the federal or state government through income taxes, gift taxes, or succession taxes. The person may get something in return—as in a sale of assets or stock—or may be transferring the management of the business or the assets to a third party.

The answer to the questions “When should wealth be transferred?” and “How can it be accomplished successfully?” is “It all depends.” Before exploring these complex issues, however, the first question to discuss is, “Why should wealth be transferred at all?” The simple answer is because if one does not transfer the wealth, then somebody else will eventually have to do it. It often is said that you can’t take it with you, but people frequently struggle trying to decide how and when to transition the control of their property. If people do nothing during their lifetime, most state legislatures do it for them. Many states have statutes that set forth who will receive the property owned at the time of a person’s passing.

Assuming it is taken care of before one’s passing, the owner of a business or assets is the only person who can answer the question of when to transfer wealth. The timing of the transfer depends on how the owner wants to use the assets, if he or she wants to continue being involved in the business, and his or her need for income from the business or the transfer of assets. To effectively transfer wealth at a specified time, one needs a plan. Decisions about how to transfer property are entirely the business owner’s to make, but those decisions generally are made with the assistance of a wealth transfer team, which usually consists of an accountant or financial advisor and an attorney, at a minimum, as well as an insurance agent, a real estate agent, and a business broker, if desired. (To learn more about how to sell a business, please see For Sale by Owner.)

Teamwork Pays Off

Before making the decision of when to sell, business owners should seriously consider the formation of a wealth transfer team. They also need a plan that will allow them to sell the business in a way that affords the greatest tax-planning opportunities, and allows for a relatively quick and easy transfer of assets. In selling a business that is operating as a corporation, the owner may consider selling just the assets of the business or selling the stock in the corporation. If the business operates as a limited liability company or a partnership, the owner may sell the assets only, the membership interest in a limited liability company, or the partnership interest in a partnership. Each of these types of sales carries with it decisions that are best made with the advice of both an accountant and an attorney. An accountant can help with tax planning and any tax-related issues that arise. An attorney can help address transferability issues set out in the owner’s agreements with the other owners of the business, as well as both pre- and post-transfer liability issues. If a business owner is conducting business in a sole proprietorship, the transferability issues are reduced in number and complexity, and it is easier to coordinate the wealth transfer.

Early planning for the structure of a business enterprise under the respective state laws will yield a great return at the time of a wealth transfer. That return may be in the form of reduced legal or accounting fees because of the ease with which the transfer may be accomplished; reduced income or transfer tax because the owner managed the business appropriately for a long time; or simple peace of mind when the sale of the business goes smoothly, allowing the owner to move on to the next stage of life, next project, or next business enterprise without any lingering worries or liabilities.

If more than one person owns the interests in a business, one owner can arrange for a sale among the others. Many times shareholders of a corporation will enter into an agreement called a buy-sell agreement or a cross-purchase agreement. These agreements generally call for one or more of the shareholders of the corporation to buy out the interest of the person who wishes to leave the business enterprise. They are sometimes funded with life insurance and are sometimes funded by the future earnings of the business. The exact name or type of agreement is, in large part, dependent on the state’s laws, the various federal and state tax laws affecting the nature of the transfer, and the tax outcomes the owners wish to achieve. These agreements also may deal with topics like the transfer of ownership upon termination of employment, retirement, disability, or death. The owners may adopt similar forms of agreement or provisions in the formation or operating documents for limited liability companies or partnerships to address issues about when and how an owner must transfer these alternative types of business interests.

A Good Game Plan

Some business owners may wish to transfer wealth to members of their immediate or extended family to continue to operate the businesses they have worked so hard to establish. A careful structuring of the business enterprise around stock ownership, ownership of the membership units, or ownership of the partnership interests may permit an orderly transition of the wealth to other family members to perpetuate family ownership of the business enterprise. Likewise, through sound structuring, funding, and operating of family limited partnerships or limited liability corporations, significant tax savings may be achieved using properly allowable discounts in valuation of the business ownership interests being transferred by gift or for value. Depending on the nature of the structure chosen, business owners may achieve a reduced tax obligation either at the time of the wealth transfer or at the time of their passing.

Accountants and tax attorneys, as members of the wealth transfer team, can advise on the proper discounts that may be applied to value the business owner’s interests. A business broker can help with proper valuation of business interests and preparation of the supporting documentation. Together, the team can establish a reasonable and supportable plan for transferring business interests either during the owner’s lifetime or at the time of the owner’s passing.

Sometimes business owners who want to retire look to the business they have established as their “retirement fund.” If the wealth transfer is part of a retirement plan, care should be taken to determine the retiring owner’s long-term cash needs. The transaction then may be structured to create a lump-sum payment that may be invested in other assets, an income stream that may be received over the remaining life of the retiring owner, or a combination of the two. Again, the advice of an accountant and an attorney will help establish the payment methods and terms that will ensure that the proceeds will be there when the former business owner needs them.

Many times a small-business owner also owns the real estate where the business is located. If this real estate is essential for the ongoing operation of the business, it frequently will become one of the topics of discussion among the wealth transfer team. As part of a retirement plan, it may be prudent to sell either the business interests or the assets of the business while retaining ownership of the real estate to provide a future income stream for the owner’s retirement. A separately structured sale of the real estate may generate a lump-sum payment for an alternative investment or an income stream for the benefit of the owner.

Some business owners may decide to continue to own, operate, and control their businesses and wealth until they are no longer able to do so. If so, they must consider whether they will transfer their business interests and wealth when they can no longer manage them, or if they will keep them until they pass away. If an owner is not able to transfer the business interests during his or her lifetime because of physical or mental incapacity, someone else will have to do it. The question is, Who will that be?

In Ohio, for example, if one has not appointed someone to act for him or her, the probate court in the county of the owner’s residence appoints someone to do it. Most business owners would prefer to choose their successor or the person they wish to act for them. This successor in interest may be a relative, a bank, or a professional adviser. The successor in interest may be an attorney-in-fact under a financial power of attorney, a trustee of a living trust, or the executor of the owner’s estate. In any of these events, it is necessary to name the successor in interest in a formal, legal document. This legal document also may set out the powers the person wants the successor in interest to exercise, when those powers may be exercised, when the powers should cease, and what happens to the wealth when the successor in interest may no longer exercise any power over the assets. If a business owner does not plan for the transfer of wealth, someone else will do it sooner or later.

While it doesn’t take a village to transfer wealth, it does take a team. The business owner is the captain of that team, deciding when and how to transfer the accumulated wealth. The owner’s teammates work to ask questions, make suggestions, and implement decisions. The time to start assembling a team and establishing a plan is now.