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Wealth Transfer Planning: What Your Investment Banker Didn't Tell You

By Alan K. Davis on March 2, 2016

Just like real estate brokers will help you stage your home before they list it, investment banks and commercial banks will advise you to perform a corporate house cleaning before you begin to market your company. 

A few common “due diligence” questions you may want to ask yourself include:

  1. Are the books and filings up to date?
  2. Is the stock (or other ownership interest) accounted for and owned by non-minors? 
  3. Does the company own personal assets that need to be removed in a tax efficient manner?

They know that by addressing these and other matters early, when you have the time to take the appropriate action, you may greatly increase the value of your company. 

What they may not tell you – and in our experience, frequently do not tell you – is how to optimize your business for your personal wealth transfers. It is important to consider the various planning techniques that leverage asset transfers to maximize the benefit to yourself, your family and/or charities.  Consider, for example, the following planning techniques that may be appropriate prior to the sale of a family business.

Grantor Retained Annuity Trusts. Also called GRATs, these Trusts allow you to transfer a minority interest in your company to a Trust which ultimately passes to your children after the expiration of an initial term. During this initial term, however, you retain the right to an annuity payment equal in value to the value of the interest that was transferred. The actuarially determined value of the remainder is a gift to your children, but you can structure the annuity so that the remainder interest is worth zero.  As a result, no taxable gift occurs. If the company is sold during the initial term, the GRAT is entitled to its share of the sale proceeds. The value of these sale proceeds will almost always be worth more than the initial value for several reasons. First, the initial value was reduced by lack of control and lack of marketability discounts. Second, GRATS will be “grantor trusts” for income tax purposes meaning that you will pay the income tax liability on behalf of the GRAT so that it will retain the pre-tax proceeds. A significant amount of family wealth may be transferred with no transfer taxes if correctly implemented in front of a liquidation event such as the sale of a business.

Sale to an Intentionally Defective Grantor Trust. Similar benefits to that of a GRAT may be accomplished through the use of an intentionally defective grantor trust (or IDGT). This technique consists of establishing a trust called an IDGT and then selling a portion of the company to the trust in return for a promissory note. The amount of the note will reflect the value of the interest purchased which will again reflect the minority status of the interests. Following the sale, the IDGT will receive its portion of the sale proceeds and like the GRAT you will be liable for the taxes.

In both the GRAT and IDGT plans, your payment of the income taxes on behalf of the Trust is not a gift or taxable transfer to the Trust. In general, the IDGT plan is more flexible and has planning advantages that the GRAT lacks, but the GRAT plan may be the more conservative alternative as the technique is sanctioned by the IRS if done correctly.

Charitable Remainder Trust.  A third technique that may be implemented to your advantage before a sale of a company is a charitable remainder trust or (CRT). If you are charitably inclined this technique may allow more wealth to be accumulated and passed to charity while simultaneously benefiting you or another family member. Like the GRAT and IDGT planning, it is critical that a CRT plan be considered and implemented well in advance of the sale.

Selling a business can be an exciting and hectic time. Therefore the time to prep your company for the sell and consider implementing one or more planning techniques to maximize the benefit of the sale proceeds is before the chaos that ensues once a purchaser surfaces.