What started as an idea and dream is now a thriving business. At 67, you’ve poured your life’s energy into the company and, though you love your work, you’re ready for more time with the family. It’s time to sell the business and move on to the next chapter.
When the business valuation comes back, you discover that your company is worth just over $20 million! You’re also informed that, when you sell, you’ll pay a 20 percent capital gain tax and a 3.8 percent investment surtax on the $18 million gain — a whopping $4.28 million straight to the IRS — ouch!
This raises some big questions:
- How can I reduce this tax bill? Or am I just stuck with it?
- How will I create reliable income for my family for the rest of our lives?
- Once our needs are met, what kind of impact can we make on the kids, grandkids and causes we care about?
- How do we balance all these priorities?
It’s hard to not get overwhelmed, but you have options — you certainly aren’t stuck. It will help to start with a question: Is flexibility and simplicity or tax savings most important to you? Your answer will help guide you to the best mix of strategies. In general, you’ll pay more taxes if you prioritize simplicity and flexibility and can save more in taxes with a bit more complexity.
An Education in Taxes
With that in mind, let’s walk through a few options, from simple to complex:
101: Sell your business and pay the taxes.
Sell for $20 million, send $4.28 million to the IRS and reinvest the remaining $15.72 million to create income for you, gifts to the grandkids and charity as you see fit from there.
You’ll pay tax on the investment proceeds along the way and you’re likely to owe some estate taxes when you leave the balance to your family. This is simple, yet the IRS wins more of your dollars.
201: Spread the tax out with an installment sale.
Rather than selling all at once, you receive a down payment upfront and the remaining sale proceeds with interest over annual installments. You pay capital gain taxes on the funds you receive each year and, as a result, you spread out the tax bill.
However, because you’re receiving payments over time rather than all up front, you’re now effectively the bank and you add a significant risk carrying a note for the new owner. If they do not perform and the business goes under, you lose. With these risks weighed, this can be a good way to reduce and defer some of those taxes.
301: Have charitable goals? Gift shares to a donor-advised fund.
Gift a portion of the company shares to a donor advised fund before you sell. A DAF is a charitable giving account that allows you to grow and sell these company shares tax free. You get a tax deduction in the year you make the contribution and can give the proceeds over your desired timeline.
As an example, say you gift shares worth $2 million of the $20 million to your DAF and then sell them. To start, you receive a charitable income tax deduction on that $2 million gift that saves you $700,000 in taxes (assuming a 35 percent tax bracket). And, because you don’t pay capital gains tax on shares sold inside the DAF, you’re effectively giving $428,000 to charity that would otherwise have gone to the IRS. In this scenario, you’d give $2 million to causes you care about, $3.2 million to the IRS and receive the remaining $14.8 million. Charitable deductions have limits based on your situation, so be sure to consult your tax advisor.
401: Keeping the business in the family? Use an intentionally defective grantor trust.
You sell the business to the IDGT in exchange for a promissory note. You won’t pay capital gains tax on the sale, but you will pay income taxes (the ‘defective’ part) on income from the trust and interest received on the note. The business is also removed from your estate, so as it grows, your estate tax bill will not. When you die, the business transfers to the next generation free of any capital gains or estate taxes.
As an example, you would sell your $20 million business to the IDGT in exchange for a 2 percent interest only note. Rather than a lump sum, you will receive $400,000 per year in note payments for life. While you’re alive, the business continues to grow and is operated by the next generation and, when you die, the business transfers to them with no additional taxes due.
While you give up the flexibility you’d have with a large lump sum of cash, you’ve also saved a hefty tax bill.
501: Want to generate income for you, give more to charity and leave more to family? Combine a charitable remainder unitrust, donor advised fund and a wealth replacement trust.
We’re in more complex territory, but you significantly increase your impact with this blend of strategies! To illustrate, we’ll jump straight to an example. With a $20 million business value, you allocate:
- $2 million to your donor advised fund. You sell the shares tax free, receive a $700,000 charitable deduction and fund charitable goals throughout your lifetime.
- $5 million to a charitable remainder unitrust. You sell these shares tax free, receive an income tax deduction today, receive income for a designated number of years and leave the remaining balance to charity.
As an example, in this case, a 20-year CRUT creates $850,000 in income tax savings and $250,000 income per year for 20 years. Note: The tax deduction can be spread over five years, which might be necessary to use the whole deduction.
- Between your donor advised fund and charitable remainder unitrust, you’ve saved a bundle in taxes and transferred $7 million out of your estate — which also reduces the legacy assets for the family. So, you give your $250,000 annual CRUT income to a wealth replacement trust. The trust purchases a life insurance policy designed to leave $10 million to your family income and estate tax free when you die.
- You have $13 million left. You’ll pay $2.8 million in capital gains taxes, but after we add back the $1.25 million in charitable tax savings — $850,000 for the CRUT and $700,000 for the DAF – you have $11.75 million to use for retirement income.
To summarize, you’ve created $28.75 million in value for you, your family and causes you care about from a $20 million sale — a 43 percent increase!
- $7 million to charitable causes you care about
- $10 million tax-free to your family
- $11.75 million to you for retirement income
- The IRS share is reduced by over $3 million — down to $1.25 million from $4.28 million
With so many options available, how should you choose the right mix of strategies? This is where a coordinated team comes in: a business transition expert, attorney, CPA and financial planner. A clear vision and a qualified team can help maximize your impact as you turn the page to the next chapter focused on family, friends and the causes you care about.
What's the best path for your business?
About the Author
Grant Monson (CFP®, CLU®, ChFC®) is a partner and financial advisor at Alterra Advisors. He grew up on a working wheat farm in eastern Washington. Today, he credits his family, who still manage the farm, for preparing him to build a business serving others. His vision to lead Alterra is built on relentless dedication to the success of his clients and the team — his extended family.
Grant earned a bachelor’s degree in business and a master’s in economics at Washington State University. He launched his own financial advising practice over a decade ago, an entrepreneurial quest that has become one of the most impactful things in Grant’s life. He loves coordinating the complex financial lives of business owners, bringing a depth of understanding that is rooted in his family’s own experience.