It’s hard to believe that the youngest Baby Boomers, born in 1964, turned 55 in 2019. With millions of Americans in retirement — or thinking about it — the need for “exit planning” among small business owners is at an all-time high.

Even if you’re not yet in retirement mode, proactive planning can help maximize the proceeds you (or your estate) will receive when your business interest is eventually sold or liquidated. After all, not all exits are planned; some owners unexpectedly leave the business.

Making Intra-Family Transfers

Family businesses sometimes employ the owners’ children or grandchildren. But you shouldn’t assume that members of younger generations have the skills or interestto take over the reins when you leave. Exit planning requires honest family discussions about whether loved ones are willing to learn how to make daily business decisions and can pay for their ownership interests.

Some business owners don’t expect family members to buy in to the business. Instead, they may gift shares to them. Current tax law provides a great opportunity for gifting programs: For 2020, the annual federal gift tax exclusion is $15,000 and the federal unified gift and estate tax exemption is $11.58 million (up from $11.40 million for 2019).

These allowances mean you can transfer significant equity in your business without incurring any gift or estate taxes. Any gifts in excess of the annual gift tax exclusion are taken against your lifetime unified gift and estate tax exemption. However, to the extent you use this credit against a gift tax liability, it reduces (or eliminates) the credit available for use against the federal estate tax at your death.

Final regulations published by the IRS in 2019 confirm that gifts made under today’s generous gift tax rules won’t be “clawed back” if the donor dies after 2025, when the federal unified gift and estate tax exemption is scheduled to decrease. Under a special rule, an estate will be allowed to compute its estate tax credit using the higher of 1) the exemption amount applicable to gifts made during life, or 2) the amount applicable on the date of death.

Important: Beware of state death tax rules. The gift and estate tax allowances that apply in your state may differ from federal allowances.

Creating an ESOP

What happens when family members are unable or unwilling to take over the business after the owner leaves? Sometimes, the next best thing to family is the company’s employees. An employee stock ownership plan (ESOP) is a defined-contribution retirement plan in which employees become owners over time by setting up an employee benefit trust. Usually, the current owner sells stock to the trust, and the trust borrows money to purchase the stock. Qualifying contributions are a tax-deductible expense for the company.

Complex rules and conditions apply to ESOPs. So, if you choose this alternative, you’ll need guidance from legal, employee benefits, valuation and tax professionals.

Selling to a Strategic Buyer

Sometimes the only option is to sell your business to a third-party buyer. To maximize the selling price, you should always run your business as if it’s up for sale. Businesses that are sale-ready may sell for a premium if they can find a strategic buyer, such as a competitor, customer or private-equity investor, who can achieve synergies through cross-selling opportunities and economies of scale.

Selling to a third party can provide you with income during retirement (or to your heirs after you die). Rather than receive a lump-sum payment, consider deferring the tax hit over several years by incorporating into the terms of the deal either installment payments or an earnout clause that’s contingent on achieving certain performance goals. You also may be asked to sign noncompete agreements and possibly even provide consulting services for several months or years to help the buyer take over daily operations.

We Can Help

Other options for businesses with more than one owner are to sell a departing owner’s interest 1) to the other owners, or 2) back to the business. A buy-sell agreement can facilitate these transfers. We can help you evaluate the buyout clause of your buy-sell agreement to ensure that all the bases have been covered.

Our team can help evaluate your options for exiting your business and provide a realistic estimate of your business’s fair market value. Contact us for more information.