“Retiring? Have you Taken Care of Business?”

Your years and years of hard work have finally paid off, and you are ready to transition into retirement living. However, there are still nagging questions regarding what is going to happen to the business that you worked so hard to create. Who will run the company? Are you going to have any continuing input or, better yet, continuing income from the business? Is the business going to be sold to a third party or competitor, or to an existing employee/management team? Or is the business going to be gifted to a son or daughter who has been groomed to be your successor? What about the tax implications? These are just a few of the questions you need to consider before you make retirement your next full-time occupation.

Most business owners have a pretty good idea of what their business is worth, but may not fully recognize the tax implications involved with the sale of the business assets. The primary concern in these types of transactions is the capital gains tax which would result because of the combination of appreciation in the value of the business combined with depreciation taken over time. Business owners should consult with their tax advisors before entering into any agreement to sell in order to ascertain what the capital gains tax consequences would be. Also, there are options, such as an installment sale, which can be used to defer the recognition of gain over time. In some situations, it may be possible to avoid or minimize the recognition of gain by using charitable planning as part of the business transfer process.

Another issue to be addressed in business transfers is whether or not you will retain some interest in the business as a going concern. This can be in the form of a consulting agreement, an employment contract or similar arrangement, which can be negotiated as part of purchase price. If you intend to retain some aspect of interest in the business, you should also make sure that the buyers have the know-how to keep the business running, especially if you intend to supplement your retirement income from this retained interest in the business. If the buyers run the business into the ground, that additional stream of income would disappear. Also, do you foresee possibly getting back into the business if the retirement lifestyle doesn’t fit the bill? You may be asked to sign a "non-compete" agreement as part of the sale that could restrict your ability to start a new, competing company.

Very often business owners want to transfer their interest in the family business to the younger generation who has been groomed to continue to keep the family business running. If the transfer of the business is to take place by gift during lifetime or inheritance at death, transfer taxes (gift and estate taxes) need to be taken into account. In addition, business owners may want to make equalizing transfers to other family members who are not involved in the business. This is generally very difficult to achieve, especially where the business makes up the majority of the estate assets.

There are methods available to reduce the gift and estate taxes involved with the transfer of the family business to the next generation. Depending on how the business is structured, "discounted" gifts of minority interests or non-voting interests in the business stock can be transferred. The discounted value of these transfers reflects the fact that, on a fair market value basis, minority or non-voting interests in a business are worth less than a majority or controlling interest.

Also, the business structure can be modified to make these types of transfers easier to effect. For example, if a business is incorporated, but there are only 100 shares of stock in the company that have been issued (and all of the shares are owned by the senior generation), it is possible to "re-capitalize" the company so that instead of 100 shares being issued 10,000 shares are issued. Obviously, the underlying value of the company does not change, but the value of the company that each share represents is substantially reduced. The senior generation can gift, over time, smaller, less valuable "pieces" of the company.

With regard to "equalizing transfers" to other family members not involved with the business, obviously if there are sufficient non-business assets available for this purpose modifications to the senior generations’ estate plan can be made to accomplish this. If, as is more often the case, there are not enough other assets to accomplish this, the business owner can consider using life insurance (either owned by the other children or in an irrevocable life insurance trust) to provide a tax free "equalizing " benefit to the other family members.

The type of sale transaction for the transfer to a buyer also needs to be addressed. As indicated above, for example an installment sale can be used to spread out the recognition of any capital gains tax that may be incurred as a result of the sale. However, there are other strategies that should be reviewed. Is the transaction going to be structured as a sale of the business’ underlying assets (e.g., inventory, accounts receivable, good will), or will the transfer be structured as a "stock sale"? These considerations, and others, can significantly effect the tax ramifications to both the buyer and the seller, and, as such, need to be scrutinized by legal & financial advisors. If an installment sale is used, what type of protection or collateral will the seller retain to protect future payments? In cases like this, the seller may actually retain the stock to hold as collateral, or the buyer may be required to purchase a life insurance policy on his or her life, payable to the seller, which can be used to pay off the balance of the loan in the event of the buyer’s premature death. Also, it is not uncommon for the buyer to have to sign a personal guarantee to insure future payments to the seller.

If you are purchasing a company, there are some other factors to be considered. For example, if real estate is involved the buyer should take steps to make sure that there are no environmental issues connected with the property, not only from the seller’s use of the property, but from the use by prior owners as well. In technology areas, the buyer should make sure that any software being purchased is not only up to date, but that the software licenses are current and transferable as part of the sale. The same considerations should be given to any computer equipment/hardware. It is not uncommon to find that the computer software being used by the company is not only out of date, but also that the vendor/manufacturer has gone out of business, been bought out or is no longer servicing that particular software version.

These are just some of the issues that need to be considered by both buyers and sellers before entering into these types of transactions. As a buyer, you obviously want to make sure you are getting what you are paying for. As a seller, you want to make sure that you are able to obtain the value from the company without substantial negative tax consequences so that, over the course of your retirement, you do not find yourself looking for part-time employment.