CONSTRUCTION Accounting ARTICLE -
Ensuring a Successful Succession : 3 Key Methods to Transfer Ownership

A good succession plan is a necessity for every construction company. And among the most important parts of any viable succession plan is precisely how to transfer ownership to both provide the departing owner with funds for retirement (or for another purpose) and ensure that the business continues to thrive. Here are three common methods to consider.

1. Selling your stake

By selling your ownership interest, you remove its potential future appreciation from your estate and receive income either in the form of a lump sum that you can invest or periodic payments on an installment note.

Sometimes, a sale may be structured to take advantage of lower long-term capital gains rates and creative financing can be used to help the next generation to make the purchase.

Often, however, the tax impact or a lack of liquidity on the part of the buyer makes a “straight sale” unappealing and makes it worthwhile to consider another method for transferring ownership.

2. Giving it away

If your succession plan involves family members, annual exclusion gifts are another option. You can gift $12,000 per recipient per year free of gift tax ($24,000 if you split gifts with your spouse) and without using up any of your $1 million lifetime gift tax exemption.

Annual exclusion gifting also can help preserve your estate tax exemption (the amount you may pass estate-tax free at death) — $2 million for those dying in 2006 or 2007. Why? Because the exemption available at death is effectively reduced by the amount of taxable gifts you make during life, but not by annual exclusion gifts.

Nonetheless, there’s nothing wrong with using some or all of your $1 million gift tax exemption — especially if you’re getting a potentially rapidly appreciating asset out of your estate.

You may be able to further leverage the gifts with valuation discounts. For instance, you may be able to claim that the gift of a minority interest is worth less than its share of the underlying value of the assets, thereby allowing you to transfer a larger proportionate interest tax-free. But discounts also may trigger IRS scrutiny as to whether they are too big — or warranted at all.

Another potential disadvantage is that, using annual gift exclusions, you’ll likely need many years to transfer an entire business. Thus, many business owners use annual gifting only in conjunction with other methods.

3. Making a “partial” gift

Trusts can often provide the most appropriate means for transferring a business. In succession planning, one common vehicle is the grantor retained annuity trust (GRAT).

A GRAT is an irrevocable trust that can be funded with your construction company stock and from which you receive an annuity (calculated using the IRS’s Section 7520 rates) for a term of years.

Funding a GRAT does create a taxable gift (and possible use of your lifetime exemption) to the extent that the value of the assets contributed exceeds the current value of the annuity payments due back to you.

The tax leverage of a GRAT comes in two ways:

1. You gain tax leverage if an appraisal on funding supports a discounted value of the stock, allowing you to transfer more shares at the same gift tax price.

2. Fewer and fewer shares of stock are needed to be paid back to the grantor to fund the annual annuity payments to the extent the company stock appreciates at an annual rate greater than the Sec. 7520 rate.

The fewer the shares needed to fund the annuity, the more shares will be left in the trust to pass free of estate tax to the GRAT’s beneficiaries. If you die before the expiration of the term, however, the entire GRAT is pulled back into your estate, thereby nullifying its tax advantages.

Don’t fail to plan

Failing to create a succession plan could trigger a tragic financial and strategic failure when it comes time to pass your construction company on to the next generation. And even if you’re not considering retirement anytime soon, you still need a succession plan in case an unexpected event takes you away from the business.

Find out how our expertise in construction accounting can add value to your business. Email us or call us at 1 (888) 875-9770.

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