CONSTRUCTION Accounting Article -
Fare Well After Your Farewell
Succession Planning for Family Construction Businesses

You’ve spent years developing a successful family construction business. But now you want to cut back on the long hours and enjoy the fruits of your labor.

Yet you can’t just stop showing up and expect the money to keep rolling in. You need to figure out how to transfer the company to provide yourself with a good retirement income with the least amount of tax pain.

You must also ensure that your company will carry on after you’re gone. A significant number of businesses don’t survive the transition from founder to second generation. And, often, excessive taxes triggered by the transfer lead to their demise.

Fortunately, a wide array of succession planning methods exist to help you safely transfer ownership of your construction company.

Selling: Simple, if well structured

Among the simplest ways to pass on your business is by selling its stock or membership interest. Doing so generates an income stream for you while removing stock from your estate. That way, future appreciation accrues to the buyer. Moreover, capital gains rates are relatively low right now — generally 15% — which creates a favorable environment for stock sales.

Finding a willing and able buyer within the family, however, can be difficult. You may need to structure the sale creatively to make it work for everyone. For instance, you could opt for an installment sale. But you would need to adhere to strict rules that regulate installment sales between related parties.

Gifting: An estate planning plus

You can also transfer ownership to the next generation through gifting. You may take advantage of your annual gift tax exclusion (currently $11,000) to make gifts over time.

Or, if you anticipate a faster transfer, you can gift an amount up to the unified credit, which currently shelters $1 million in transfers without incurring additional gift taxes. Any gifts beyond that amount are taxable to the person making the gift (also known as the "donor").

As with selling, an advantage of gifting is that it removes the stock from your estate and transfers future appreciation to the donee. But there are disadvantages, too. You may incur gift taxes if the value of your ownership shares is substantial, which is likely considering you own the business. Additionally, gifting doesn’t produce an income stream for you.

You also risk IRS scrutiny. Be sure to obtain a formal valuation of your ownership interest to avoid future problems for your estate.

Creating a trust: Complex but powerful

A trust may serve as a more creative mechanism for transferring ownership to the next generation. One option is the grantor retained annuity trust (GRAT). It has become a more prevalent way to shift appreciation to younger family members in a tax-advantaged manner.

To create one, you fund an irrevocable trust with assets — in this case, your construction company’s stock. In turn, the trust pays a percentage of the initial contribution back to you for a term of years.

At the end of the term, the trust distributes the remaining assets to the beneficiaries, who must be someone other than you, the donor. The transfer of assets into the trust is a taxable gift to the extent it exceeds the unified credit.

But the gift’s value is reduced because of the annuity the GRAT is required to pay. And, as long as the GRAT assets generate a larger return on investment than the rate of return assumed by the IRS, it will effectively transfer your wealth while lessening the tax impact of doing so.

One drawback, though, will occur if you die before the end of the annuity period. In that case, the trust assets will be included in your estate, nullifying the GRAT’s advantages.

To avoid this problem, you might sell the stock to an intentionally defective irrevocable trust (IDIT) instead. Here the stock is sold to the trust, but no gain recognition occurs because the trust’s creator is treated as the owner for income tax purposes.

So, in return for the stock, you receive an interest-bearing note for the stock’s fair market value. And to the extent the stock generates a higher yield than the interest rate on the note, the excess will pass to the trust beneficiaries free of gift or estate tax.

Succeeding: Your only option

Creating a good succession plan will produce the funds you need to retire while ensuring your business continues to thrive. Remember, in this endeavor, success is your only option. Anything less may mean a more stressful retirement and the eventual demise of your construction company.

Sidebar: 6 keys to unlocking a winning succession plan

1. Start early. Begin planning your departure at least five years before you wish to leave the company, though 10 years is ideal.
2. Don’t go it alone. Involve your entire family in succession planning discussions.
3. Divide your estate equitably. Every child doesn’t need an equal share of the business; you may use other assets to achieve fairness.
4. Pick a practical replacement. Be realistic when looking for successors — don’t expect to find someone exactly like you, but don’t hand over your company to the easiest choice either.
5. Teach your successor well. Take the time to educate your replacement about the business skills he or she will really need.
6. Obtain outside advice. Succession planning is no simple matter — involve your attorney, accountant and any other advisors you feel will help.
   

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

related links

Construction Newsletters & Articles

Specialized Construction Services

Construction Contract Audits

Construction Resources

Auditing & Accounting

Seminars & Events