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Succession Planning: When It’s Time to Pass the Baton (Part 2)

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(Photo © iStockphoto / Hadel Productions)

Mark E. Battersby |

More Than Just a Matter of Deciding Not to Go to Work Anymore

ARDMORE, Pa. — Sooner or later, every dry cleaner thinks about retirement. For those who own a closely held or family business, retirement is more than just a matter of deciding not to go to work anymore. In addition to ensuring there will be enough money to retire, dry cleaning business owners, shareholders and partners must decide what will happen to the business when they are no longer in control.

An effectively developed succession plan can involve selling the business to provide a retirement nest egg, or continuation of the dry cleaning business, with gradual changes in management and/or control, to ensure a source of retirement income or any combination thereof.

One of the more important aspects of business succession planning is working out the financial pitfalls following the death of the business owner. That requires answering questions such as where the money to pay taxes will come from, or, if the business is a partnership, where the money to buy out the deceased partner’s share will come from.

AN OUTRIGHT SALE

To keep the income rolling in without having to show up for work every day, succession planning might look at selling an owner, shareholder or partner’s interest in the dry cleaning business outright. When the business interest is sold, the seller receives cash (or assets that can be converted to cash) that can be used to maintain the seller’s lifestyle, or pay his or her estate taxes. 

The time to sell—now, at retirement, at death, or anytime in between—is optional. As long as the sale is for the full fair market value (FMV) of the business, it is not subject to gift tax or estate tax. Of course, a sale that occurs before the seller’s death may be subject to capital gains tax.

LIQUIDITY STRATEGY EQUALS CASH

So-called “liquidity” strategies permit a dry cleaner to take cash out of the business in exchange for the transfer of assets to another individual. While liquidity options are most common with sales of the business to a third party, they can also be used when the assets are being transferred to family members or business insiders (such as partners).

A private annuity involves the sale of property in exchange for a promise to make payments for the rest of the seller’s life. Here, ownership of the business is transferred to family members, or another party (the buyer). The buyer, in turn, makes an unsecured promise to make periodic payments for the rest of the seller’s life (a single life annuity), or for the seller’s life and the life of a second person (a joint and survivor annuity).

A joint and survivor annuity provides payments until the death of the last survivor; that is, payments continue as long as either the husband or wife is still alive. Again, because a private annuity is a sale and not a gift, assets can be removed from an estate without incurring gift tax or estate tax.

A self-canceling installment note (SCIN) permits the transfer of a dry cleaning business to a buyer in exchange for a promissory note. The buyer must make a series of payments to the seller under that note. A provision states that upon the owner’s death, the remaining payments will be canceled. SCINs provide for a lifetime income stream and avoidance of gift tax, and estate tax in a manner similar to private annuities. But unlike private annuities, SCINs give a security interest in the transferred business.

SUCCESSFULLY PLANNING SUCCESSION

Developing a succession plan is a multi-phase process outlining, in detail, who, what, when, why and how changes in ownership and management of the dry cleaning business are to be executed. At a minimum, a good plan should help accomplish the following:

  • Transfer control according to the wishes of the operation’s owner, shareholder or partner
  • Carry out the succession of the business in an orderly fashion
  • Minimize the tax liability of all involved
  • Provide economic well-being after the owner, partner or shareholder steps aside

Obviously, dry cleaning business owners seeking a smooth and equitable transition of their interests should seek competent, experienced advisers to assist them in this matter. No matter how talented and earnest those professional advisers are, their limited specialties should never dictate the choices for the business or for the owner, shareholder or partner’s family. 

A tax lawyer can make compelling arguments for strategies that can minimize estate and gift taxes. A CPA can be convincing when suggesting strategies for controlling income taxes. And it is a similar story with financial planning and insurance professionals. In fact, tax planning should never control any business decisions.

Finally, succession planning isn’t something that can done once and forgotten. To be complete and effective, a succession plan must be continually revisited, reviewed and updated to reflect changes in the value of the dry cleaning operation, market conditions, and the owner, shareholder or partner’s health, as well as the abilities and passion of the people to whom it will be passed.

Click here for Part 1!

Information in this article is provided for educational and reference purposes only. It is not intended to provide specific advice or individual recommendations. Consult a tax adviser for advice regarding your particular situation.

About the author

Mark E. Battersby

Freelance Writer

Mark E. Battersby is a freelance writer specializing in finance and tax topics based in Ardmore, Pa.

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