At the end of 2010, Congress increased the lifetime gift tax exemption to $5 million (up from $1 million) for individuals and to $10 million (up from $2 million), for married couples. These changes, however, are set to expire in 2013, creating a two-year window of opportunity for business owners to keep more of the family business in the family and less of the business from going to Uncle Sam in the form of federal estate and gift taxes.
But smart tax planning is only one aspect of good estate planning. While it may seem like both a loving gesture and tax-advantaged move, gifting can sometimes be the worst possible option for both the business and the family that owns it.
According to a number of U.S. Small Business Administration reports, roughly 90 percent of U.S. businesses are family firms. Yet, only 30 percent of these companies successfully transition from the first to the second generation, and a mere 15 percent survive into the third generation.
There are reasons for such long odds.
Succession planning for a closely held business is difficult for two primary reasons: Equity in a family business is unique in that it often has substantial value but limited marketability; and family relationships often make dealing with that asset emotionally charged.
A business succession plan can be derailed if there are hostilities among the children, if one or more of the children have unrealistic expectations, and/or if the owner and the owner’s spouse disagree regarding the children’s current and future roles in the business. Indeed, if such obstacles exist, the plan may not be initiated, completed or implemented.
Many owners intend to transfer their business interests to particular children who will run and/or actively participate in the business’s operation. Often the business is the largest single asset in the owner’s estate and the owner may feel pressured to also pass some ownership interests to children who are not actively involved in the business. When business interests are gifted in these situations, conflicts are inevitable.
Much can be learned from instances of successful business succession involving sales rather than gifts of business interests. A sale can help preserve the family’s true legacy – not the business itself but the two most precious things that the business creates: substantial personal wealth and the values required to nurture the next generation of entrepreneurs. A sale can also provide cash for equalizing gifts to children who are not active in the business.
Building great families is often at odds with building great businesses. Family and business work in equal but opposite directions, with family thriving on fairness, and business thriving on decisive control and leadership. Regarding the latter, leadership of the family business should be determined by the child or children who express an appetite for risk and hard work. These qualities are hard to find in most traditional family businesses that end up being gifted.