Meet Ted. Ted is a C Corp owner who is ready to retire by selling his $1 million worth of stock in the business. Not a bad retirement, right? Let’s take a closer look. The long-term capital gains tax for Ted is $240,000. And the buyer? His tax bill is even worse. Let’s say, in this scenario, the buyer’s income tax bracket is set at 39.6 percent. With federal income tax and net investment income tax combined, the buyer needs to generate an added $665,600 in order to walk away with that same $1 million in stock. Consider now that this is a family business. All combined the sale of that $1 million in stock — just to pass it from one generation to the next — cost Ted and his heir $895,600. That’s equivalent to a tax rate of 54 percent!
Today’s economy can make family succession about as challenging as it can be. Consider this: Japanese temple builder Kongo Gumi, the longest running family business in the world, closed up shop in 2006. It was founded in 528 A.D. Imagine the hardships this family business faced in its 1,400 years of operation! Yet, it was the current business climate that did it in. How? Beginning in the 1980’s, recessions and industry changes came faster and harder than ever before. The long-standing business could not keep up and succession became impossible.
Whether your end-goal is family succession, selling the business, or dissolving it when you retire, start strategizing now and be prepared to change course when needed. In fact, give yourself 10 years to do it right. It takes that much time to alter your course from “build mode” to “exit mode.” Here’s why (including links to previous posts for more information):
1. You may want to methodically change strategy to increase business value. While growing the business and reducing liabilities may not have been important in the early stages, they may be critical to getting top dollar if you decide to sell. Asset building is a key offering from Steven Bankler, CPA, and with good reason.
2. Social Security can be a sticking point. Getting the most out of Social Security benefits when you retire requires long-term strategic planning. By the time you’re 10 years from retirement, you have precious little time left to make adjustments in order to come out ahead.
3. Family succession planning takes time. Transitioning slowing and thoughtfully can reduce strain on family relationships, which is critical for a family business to survive.
4. As explained above, taxes can destroy an otherwise rock-solid exit. But don’t be lured by low taxes alone. Sometimes paying more in ordinary income taxes, instead of capital gains taxes, can actually increase the net after-tax proceeds the seller receives.
5. You never know when the opportunity will arise. You may assume that retirement will happen at the age of 70, for instance, but what if the conditions are ripe earlier? If the right buyer comes along sooner than expected, will you be ready? Take the advice of our client Randy Smith and you will be.
6. The business structure that’s right for you now, may not be right for transition. The right business structure (whether it’s an LLC or a corporation structure, for instance) can make all the difference when it comes to tax savings and asset protection. But as your business and exit planning needs change, so might the right structure. Plan ahead and be open to changing strategy ahead of the game.
Business owners are often knee deep in day-to-day decisions. It’s hard to take the blinders off and see beyond that next inventory order. However, take a lesson from a family of Japanese temple builders. Retiring comfortably—whether through family succession or other means—takes years of planning and reinvention. It’s not a gift easily bestowed.
Image 1 Copyright: alphaspirit / 123RF Stock Photo
Image 2 Copyright: Public Domain via Wikipedia (Several Kongō Gumi workers, early 20th century)