Selling your business may be the most significant financial milestone of your life. Common questions that often arise include:

• What is my business truly worth?
• How can I secure the highest possible sale price?
• What’s the best way to structure the deal?

Naturally, these key questions are addressed early on by your corporate deal team. However, there are also valuable trust and estate planning strategies that are frequently overlooked—yet they can deliver benefits comparable to a substantial increase in your sale price.

TAX-SAVING STRATEGIES TO IMPLEMENT NOW

If the sale of your business is successful enough to leave you with more money than you plan to spend during your lifetime, then your remaining wealth will have only three possible destinations:

1. Your family or other loved ones
2. Charitable organizations
3. The government, in the form of taxes

Taxes, unfortunately, can significantly reduce the financial benefits of selling your business. Conducting a thorough assessment of the various taxes that may apply is essential to maximizing your net proceeds. In addition to minimizing income taxes on the sale itself, it’s equally important to consider how future taxes could impact the wealth you transfer to your heirs or beneficiaries.

While your wealth transfer goals are unique and should be addressed through a customized plan, several estate planning techniques are widely used by business owners. The following strategies are among the most effective for transferring wealth in the context of a business sale. In many cases, they offer the most value when implemented well before the business is sold.

GIFTING BUSINESS INTERESTS TO FAMILY MEMBERS

A simple yet highly effective estate planning strategy is to gift an interest in your business to your family members (or to a trust for their benefit). Interests in privately held businesses are particularly attractive for gifting due to two key features that allow for a reduced valuation for gift tax purposes:

1. Lack of Marketability:

There is no public market for shares in most privately held companies. This illiquidity reduces the value of the interest when calculating gift tax liability.

2. Lack of Control:

Typically, the gifted interest is noncontrolling— either through nonvoting shares or because it represents a minority stake. Without voting rights or operational control, the value of the interest is further reduced for tax purposes.

In many cases, gifts of business interests are made in trust rather than outright to individuals. Transferring interests to a trust—such as a generation-skipping trust or a spousal lifetime access trust (SLAT)—can provide several advantages, including asset protection, centralized management, enhanced control over how and when beneficiaries receive distributions, and the ability to keep future appreciation outside of your taxable estate.

KEY CONSIDERATIONS

To be most effective, a gift of business interest should be made before the business is formally put on the market for sale—ideally when the business value is still growing.

If properly structured, all future appreciation in the value of the gifted shares after the transfer date will be excluded from your estate and pass to your beneficiaries free of gift tax.

SALE OF BUSINESS INTEREST
TO INTENTIONALLY
DEFECTIVE GRANTOR TRUST

Another common technique that takes advantage of valuation discounts to transfer wealth to your beneficiaries is to sell an interest in your business to a trust for your beneficiaries, rather than make an outright gift.

HOW IT WORKS

Instead of receiving cash, you may choose to sell shares of your business to a trust in exchange for a promissory note—an agreement in which the trust commits to pay you the value of those shares over time. Typically, this note calls for interest-only payments (at a rate set by the IRS) during the term, followed by a lump-sum “balloon” payment at the end.

Because IRS-determined interest rates are generally lower than market rates, this structure allows more value to remain in the trust for the benefit of your beneficiaries, while requiring fewer interest payments to flow back into your estate. To strengthen the position that the trust can realistically repay the note, it is recommended that the trust begin with liquid assets equal to approximately 10% to 20% of the note’s face value—often achieved through an initial “seed gift” from you.

The trust is typically structured as an intentionally defective grantor trust (IDGT), commonly referred to as a grantor trust. This design results in you being treated as the owner of the trust’s assets for federal income tax purposes during your lifetime, even though the trust assets are excluded from your taxable estate upon your death.

While paying the trust’s income taxes may seem burdensome, it’s important to view these payments as effectively tax-free gifts to the trust. They enable the trust’s assets to continue compounding for your beneficiaries’ benefit without reduction by federal income taxes. In the event the business sells, this structure also avoids depleting the trust to cover capital gains taxes, since you—not the trust—are responsible for those obligations.

Another key benefit of using a grantor trust is that the initial sale of shares does not trigger capital gains tax. For federal tax purposes, the transaction is treated as if you sold the shares to yourself.

KEY CONSIDERATIONS

• The promissory note should reflect commercially reasonable terms, including interest payments and a defined maturity date.
• Ideally, the note should be repaid in full during your lifetime to avoid estate inclusion concerns.
• This technique is particularly valuable if you have already used most or all of your estate and gift tax exemption, since only the initial seed gift—not the full value of the assets sold—requires exemption.

CONCLUSION

Preparing and planning for the sale of a business can be an overwhelming and emotional time for a business owner. For this reason, it may be tempting to postpone thinking about how your deal will affect your family and other loved ones. If you delay, a golden opportunity to pass part of the value of your business to your family in the most tax-effective manner possible may be gone. Timely action is critical, and engaging your trusted team of advisors to assist you with valuable wealth and estate planning well prior to the sale of your business can help maximize the funds you and your family will receive in the deal.