Business Succession and Taxes: 6 Common Mistakes

Stack of papers and pens lying on a business conference table

By Brady Marlow, CFP®, AEP®,CAP®, CPWA®, CExPTM, Director, Carson Private Client Wealth Strategy 

As a small business owner, you understand the importance of safeguarding your legacy and ensuring a seamless transfer of ownership through succession planning. But amidst the complexities of organizing your exit, it’s easy to overlook tax considerations of your succession plan — and that could significantly impact your financial future. 

Understanding the intricate web of tax implications and identifying tax-efficient strategies is crucial for preserving your fiscal well-being. As you aim to optimize your tax position, here are six common mistakes business owners make when it comes to succession planning tax considerations and how to navigate them.

Mistake 1: Not Planning Your Exit Early Enough 

The earlier you start planning for your exit, the more benefit you will see. In fact, I like to say that the day you start your business is the day you should start considering the end. That’s not to say you won’t be invested in its success. But keeping an eye toward the future will enable you to make decisions that can help your business derive the most value – not only for its eventual sale, but for your tax liability. 

That could mean getting it into the right structure early. For example, converting to a C-Corp, which means you may qualify for a tax exemption on the first $10 million of your sale due to Section 1202. Or, you might decide to move your operations to a different state where you minimize the tax bite. Another option: Pay a bonus to your employees before a transaction rather than giving them equity, which allows you to reward key employees in a way that also improves your tax situation. 

I often hear small business owners lamenting that it’s now too late to leverage strategies that would have strengthened their financial outlook. The earlier you start thinking about succession planning tax considerations, the more likely it is you can put those plans in motion.

Mistake 2: Not Assembling Your Team in Advance 

Sometimes business owners don’t start thinking about their eventual exit until they’re forced to – either due to an unfortunate circumstance like death or divorce or even an exciting event, like an offer. But deals go fast once you start, and business owners often find their brain capacity is spun up on everything from due diligence to negotiations. 

Also remember that your suitor just wants to get the deal done. They aren’t worried about your personal net number and the tax repercussions. That’s where you want to have professionals who are watching out for you and are equipped to help walk you through your options and explain any complexities to make sure the deal is advantageous. 

Your team should include a CPA and an attorney, often with your financial advisor as the “quarterback.”

Mistake 3: Not Understanding the Difference Between Estate Tax and Income Tax 

I find it’s extremely common for these to become conflated, but a small business owner needs to understand both in order to maximize their tax position. 

The goal of estate tax planning is to help the next generation. Often, there are strategies you can pursue to lessen estate tax implications, but many of these need to be in place prior to the sale of a business. For example, you can gift shares at a lower value before the business sells to get them out of the estate. By contrast, income tax is what affects your day-to-day financial health and will be influenced by how you are paid following the sale (more on that below).

Mistake 4: Not Understanding How You Will Be Compensated (and the Repercussions) 

A private equity firm might come in with an eye-popping number, but the deal terms could include different forms of compensation – some cash, some stock in the new company and maybe an earn-out, where the buyer pays incrementally over several years based on the company’s performance. These will all be taxed in different ways, affecting both your income tax and your overall net worth. 

If you have different offers on the table, such as one primarily cash and one an earn-out, talk to your team of professional advisors. They can help you determine which is preferable for your economic stability — not only for the first tax year but for subsequent ones. 

Depending on who the buyer is, you may want to consider an installment sale which would allow you to receive payments over time to spread out the tax implication, particularly if you don’t need the funds immediately. This technique can be particularly beneficial in a family business because it takes into account that the buyer might be struggling to amass the purchase price all at once, making it a win-win for both parties. 

Mistake 5: Not Considering How to Maximize Charitable Contributions 

Many small business owners have philanthropic goals they want to fulfill when they sell their business. Usually, planning charitable giving before a transaction helps both your income and estate taxes. It’s important to note that you won’t end up with “more money” by taking a charitable deduction than had you not made the gift, but if you are charitably inclined, there are ways to maximize the tax savings. 

One good option that accomplishes multiple goals is a charitable remainder trust. This offers three key benefits:  

  • You get the tax deduction now 
  • You receive a lifetime income stream from the charity 
  • After you’ve passed, the charity receives the remainder of the funds

Other choices include creating a grantor retained annuity trust (GRAT), a foundation, or a donor-advised fund (DAF). Your financial advisor can walk you through the details to choose the vehicle that’s right for you and your goals, both personal and financial.

Mistake 6: Not Consulting a Financial Advisor Throughout the Process 

Having a relationship with a financial advisor well before you start making these decisions can help ensure you’re addressing both the “heart” and the “head” during succession planning. An attorney or CPA might have sage advice from a tax perspective, but it also might not suit you and your specific multigenerational dynamics. When you turn to a trusted financial advisor, they can help you look at the options through a variety of lenses related to your family, lifestyle and charitable goals. 

Your financial advisor can help you consider alternatives such as an opportunity zone, where under certain conditions new investments may be eligible for preferential tax treatment. They can help you decide if it makes sense to gift more in a given year or make a large purchase that can offset huge capital gains in that year of sale. 

And finally, your financial advisor can offer objective advice from a variety of perspectives based on your finances and beyond. Is it the right time to discuss succession planning tax considerations and how you can maximize your financial well-being? Find out more by scheduling a consultation with a Carson Private Client Strategist. 

Disclosure

Brady Marlow is not registered with Cetera Advisor Networks, LLC.  Generally, a donor advised fund is a separately identified fund or account that is maintained and operated by a section 501(c)(3) organization, which is called a sponsoring organization. Each account is composed of contributions made by individual donors. Once the donor makes the contribution, the organization has legal control over it. However, the donor, or the donor's representative, retains advisory privileges with respect to the distribution of funds and the investment of assets in the account. Donors take a tax deduction for all contributions at the time they are made, even though the money may not be dispersed to a charity until much later.  Such trusts are used to develop a vehicle for donations to a favorite charity, which also allows for the reduction of income taxes through a charitable deduction and favorable tax treatment at the date of the gift by non-recognition of built-in capital gains. The use of trusts involves a complex web of tax rules and regulations. You should consider the counsel of an experienced estate planning professional before implementing such strategies. 
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