Editor’s note: The heart attack suffered last week by Vivek Wadhwa, founder and chief executive officer of Relativity Software, triggered a great deal of discussion in the high-tech community about succession planning. Wadhwa is back at work, at least part-time. But what happens to privately held companies in the event the founder dies? Catherine Traugot already was working on an assignment when word came about Wadhwa’s attack. Carl Hibbert is business and estate planning lawyer with Kilpatrick Stockton in Raleigh. He is a N.C. State Bar board certified specialist in the area of estate planning and probate. In other words, he’s the guy you are supposed to go before you die so your family won’t have to sell the business at a fire sale price after your death.
Now that the climate is so difficult for firms to go public, Local Tech Wire asked Hibbert how a privately held company avoids the Tax Man in the event that the founder dies. As Hibbert told us, this is more a topic for a post-graduate course in tax law then a 1,000 word Q&A, but he gave it his best shot.
What is the biggest misconception surrounding the death of the owner of a closely held company?
That the business will have to be sold or it will all be eaten up by taxes.
So how does a profitable company avoid the post-owner death fire sale?
Life insurance can be used to provide liquid income that is tax-free. You can use the funds to tide the company over until an owner finds a new leader or chooses to sell, or the policy can be used to pay estate taxes by being placed in an irrevocable trust.
But if your company were valued at a $100 million, you’d need a $50 million policy to pay the taxes. What else can a company do?
There is a provision for paying taxes over time. If the company’s value makes up 35 percent or more of the person’s estate, than the federal government will let you pay over 15 years with very favorable interest rates.
You can start giving the company away to your family before your death, also?
Yes. You can transfer $11,000 a year per donee without gift transfer tax consequences -and more than that if you are willing to file gift tax returns and potentially pay state and federal gift transfer taxes. Of course, by gifting business interests (shares, units, percentages) to your family, you should have a buy-sell agreement and a restrictions in place to make sure that you can reclaim the interest in the event one of the family members gets involved in a divorce, or bankruptcy or dies.
Sometimes you see the heads of closely held companies give a child the opportunity to start a new division. I always thought this was about keeping the heir happy, but it has estate planning implications as well.
It sure does. The value of the new enterprise is not subject to estate or the gift taxes. It is excluded from the estate upon the family patriarch’s or matriach’s death because the legal entity or enterprise — the start-up venture – is owned, or partially owned by the next generation and not the decedent. A joint venture between a parent and child can also be helpful.
What about other children of a business owner that are not interested in the business, live out of state or pursue other careers … how are they dealt with fairly when distributing the family enterprise?
Give them other assets if possible, or life insurance payable to them, and keep passive players/heirs out of the ownership circle (going forward) … which is sometimes very difficult to do.
If I’m running a money-hemorrhaging start-up I don’t really need to worry about estate planning, right?
Wrong. A company could have underlying assets like patents or just be a going business with a trade name. An evaluation has to be done, and the IRS has been going after what it considers low evaluations.
So, I’d imagine you see people at all stages of company ownership sitting down to write out an estate plan?
There is still a whole lot of poor planning or no planning. They are people who were always going to get around to it. I guess they figure money or modern medicine is going to save them. Instead, it creates chaos.
How do you convince clients to do succession planning?
Often I will tell a business owner who’s too busy to do planning (sometimes a driven … workaholic type) if you will just take a few days off and devote them to this area,
you will make, conserve, save a whole lot more in the long run than what you may accomplish, generate during those few days in the office. But it is hard for him or her.
Getting back to the private companies that make money (the SAS Institute’s and such). To help me understand estate law you sent about 15-pages of descriptions of GRITS, GRATS, GRUTs, charitable remainder trusts, Family Limited Partnerships and Crummey Trusts. What’s the takeaway from all of this?
That there shouldn’t be any reason a profitable closely held company needs to be dissolved to pay taxes, assuming they’ve done their estate planning.