Connecting Your Succession Plan to Your Estate Plan

For any business owner, contractors included, putting together a succession plan may seem like an overwhelming task. Often, among the most difficult things to conceptualize is precisely how to connect — and beneficially integrate — your succession plan with your estate plan. Here are few ideas to consider.

Sell your shares

By selling your ownership interest, you remove its potential future appreciation from your estate and receive income either in the form of a lump sum that you can invest or periodic payments on an installment note.

Sometimes, a sale may be structured to take advantage of lower long-term capital gains rates, and creative financing can be used to help the next generation to make the purchase. Often, however, the tax impact or a lack of liquidity on the part of the buyer makes a “straight sale” unappealing and makes it worthwhile to consider another method for transferring ownership.

Gift your interests

If your succession plan involves family members, annual exclusion gifts are another option. You can gift $15,000 per recipient per year gift-tax-free ($30,000 if you combine gifts with your spouse) and without using up any of your $11.7 million (in 2021) combined gift and estate tax exemption.

Annual exclusion gifting also can help preserve your gift and estate tax exemption because the exemption available at death is effectively reduced by the amount of taxable gifts you make during life, but not by annual exclusion gifts. Nonetheless, there’s nothing wrong with using some or all your gift tax exemption — especially if you’re removing from your estate a potentially rapidly appreciating asset.

You may be able to further leverage the gifts with valuation discounts. For instance, you may be able to claim that the gift of a minority interest is worth less than its share of the underlying value of the assets, thereby allowing you to transfer a larger proportionate interest tax-free. But discounts also may trigger IRS scrutiny regarding whether they’re too big or warranted at all.

Another potential disadvantage is that, making annual exclusion gifts, you’ll likely need many years to transfer an entire construction business. Thus, many business owners use annual gifting only in conjunction with other methods.

Create a trust

Trusts can often provide the most appropriate means for transferring a business. In succession planning, one common vehicle is the grantor retained annuity trust (GRAT). This is an irrevocable trust that can be funded with your construction company stock and from which you receive an annuity (calculated using the IRS’s Section 7520 rates) for a term of years.

Funding a GRAT creates a taxable gift (and possible use of your lifetime exemption) to the extent that the value of the assets contributed exceeds the current value of the annuity payments due back to you.

The tax leverage of a GRAT comes in two ways. First, you gain tax leverage if an appraisal on funding supports a discounted value of the stock, allowing you to transfer more shares at the same gift tax price. Second, fewer and fewer shares of stock are needed to be paid back to the grantor to fund the annual annuity payments to the extent the company stock appreciates at an annual rate greater than the Sec. 7520 rate.

The fewer the shares needed to fund the annuity, the more shares will be left in the trust to pass free of estate tax to the GRAT’s beneficiaries. If you die before the expiration of the term, however, the entire GRAT is pulled back into your estate, thereby nullifying its tax advantages.

Plan carefully

Many construction company owners spend a long time, even a lifetime, building up the value of their businesses. Be sure to plan carefully how you’ll pass along that value when you’re ready to retire or otherwise move on. We can be of invaluable assistance in crafting both a succession plan and an estate plan, so feel free to contact us to help.

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