Secrets about business succession planning

When a business owner calls me to consult, the three most common questions I hear are: Can you help me sell/transfer, in the most tax-effective way, my business? Can you value my business? Can you give me a second opinion on my estate plan?

When a business owner calls me to consult, the three most common questions I hear are:

Can you help me sell/transfer, in the most tax-effective way, my business?

Can you value my business?

Can you give me a second opinion on my estate plan?

“Transfer” means a sale, gift, or bequest to a family member — usually to one or more of your children. “Sale” means a sale of your business to a non-family member (including an employee or fellow stockholder).

Experience (more than 50 years of it) has taught me that the right answer must encompass all three questions because a sale or transfer of the business requires a valuation; a valuation usually involves some kind of sale or transfer (both have significant tax consequences); and if you own a business, your estate plan cannot be complete without a valuation and/or a transfer/sale plan (really a succession plan).

The sale or transfer of your business can only take place in one of two important time frames: during your life or after your death. An unplanned sale after death, almost always results in a disaster: economically, tax-wise, and (my-oh-my) how the heirs (usually family) fight. So, we are going to stay in a lifetime planning mode to solve your succession problems while you are alive and well.

The secret

There’s a secret — not taught in law school — for each of the three questions.

Business Valuation: The secret is how to maximize the discount of the business for tax purposes. Here’s an example... Success Co. (owned 100% by Joe) is now run by Joe’s son (Sam). Joe wants to sell Success Co. to Sam for $8.6 million, the value determined by a professional appraiser.

Now the secret… Joe recapitalizes Success Co. (100 shares of voting stock/20,000 shares of non-voting stock) a tax-free transaction. Only the non-voting stock will be sold to Sam (using an intentionally defective trust (IDT). The appraiser updated his valuation, valuing the voting stock at $100,000 and the non-voting stock at $5.1 million (all numbers rounded). The non-voting stock is entitled to various discounts — of 40% — under the tax law, resulting in the new valuation numbers. And a big bonus to Joe: keeping the voting stock, so he can still control Success Co.

Sale of Success Co.: Here’s how I explained the tax consequences of a sale to Joe. If you sell Success Co. to Sam, each $1 million of the price will be socked with three taxes. First, Sam must earn $1.666 million. The 40% income tax (Federal and state) nails Sam for $666,000. Only $1 million is left. Then Sam pays you $1 million for your stock (assume zero tax basis). Your capital gains tax enriches the IRS by $200,000… now only $800,000 is left. At your death, the IRS siphons off another 40%, or $320,000, for estate tax, so only $480,000 is left. It’s nuts! Sam must earn $1.666 million for your family to receive $480,000.

Now the secret: Instead of an outright sale, sell the non-voting stock of Success Co. for the same $5.1 million to an intentionally defective trust (IDT). Joe gets paid in full with an interest-bearing note from the IDT.

Sam is the beneficiary of the trust and has no obligation to pay the note. Instead, the cash flow of Success Co. is used to pay the note and interest. Under crazy American tax law, every penny Joe receives for payment of the note, plus interest is tax-free: no capital gains tax, no income tax. Joe and Sam will save about $200,000 in taxes for each $1 million of the price (here about $1,020,000 in tax savings). Bless the IDT!

A second opinion of Joe’s estate plan: In addition to Success Co., Joe (and his wife Mary) have another $10.4 million in assets (including two homes, a 401(k) and various investments). The estimated tax (income tax on the 401(k) and estate tax), if Joe and Mary both were hit by the proverbial bus tomorrow, would be $3.5 million… that is based on their current estate plan.

After our second opinion, the new plan we implemented not only eliminated the estate tax, but created an additional $2.5 million in tax-free wealth (using a combination of strategies to purchase tax-free, second-to-life insurance on Joe and Mary… while funding the premium payments with the 401(k) money (which is subject to double tax: income tax and estate tax).

We also used other lifetime strategies to eliminate the estate tax: an ongoing annual gifting program to Joe’s and Mary’s three children and seven grandchildren; creating a family limited partnership for their investments, and (c) a charitable lead annuity trust (will enrich not only their alma mater — where Joe and Mary met — but their family as well).

Want to learn more details as to how their estate plan was implemented? Browse my website at


Irv Blackman, CPA and lawyer, is a retired partner of Blackman Kallick LLP and chairman emeritus of the New Century Bank, both in Chicago. He can be reached at 847-674-5295, e-mail [email protected], or on the Web at: WWW.TAXSECRETSOFTHEWEALTHY.COM.


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