When looking to sell your business, it’s possible you have potential buyers within your own family or would like to sell to family members for personal reasons.
If so, there are some special considerations as opposed to selling to a different potential buyer.
Some of these are beneficial, such as financing arrangements you’d be unlikely to consider with someone you don’t know that well. But there are also tax considerations, some of which are favorable and others that aren’t.
Here’s what to consider when deciding whether to sell your business to a family member.
IRS Scrutiny
First, the downside: conducting business transactions with family members may cause closer examination by the IRS.
They might question the price or valuation method you use, but as long as you can show you’re receiving the fair market value for the business, you should be on firm ground.
By anticipating the worst, you can avoid unpleasantness later. Utilize the services of professional financial and tax advisors before looking to sell your business to a family member. They can help you avoid the IRS contesting your valuation or bringing a gift tax assessment.
Special Financing Techniques Available
Now to the upside: when you sell your business to a family member, there are financing methods available to you and your buyer besides a lump-sum cash transaction.
These can be especially valuable when the family member buying your business doesn’t have the cash or access to enough cash to make the purchase.
Financing can be structured so that you receive a stream of income in exchange for your business while spreading out your gain on the sale over the payment period.
Here are some of the options:
- Private Annuity – The payments for your business interest are spread out over the rest of your life and the payment amount is calculated using a life expectancy table.
- If you pass away before reaching the calculated life expectancy, the buyer gets your business for less than the full price, and if you live longer, your buyer pays more than anticipated.
- The major benefit to you is the removal of the value of the business (and the future appreciation) from your estate (i.e., less potential estate tax).
- Installment Sale – This might be a suitable financing arrangement when you are willing to accept payments over time, want the additional security of a promissory note or collateral, and want to be sure you (or your estate) receive the full price for your business.
- Unlike the private annuity, the buyer using installment payments must continue making payments to you or your estate until the full price is paid.
- The major tax difference to you is that any balance still due at your passing must be included in the value of your estate for estate tax purposes.
- If you meet all requirements, you can spread your gain on the sale over the installment period.
- Self-Canceling Installment Note – This is a special form of installment note that is a hybrid of the private annuity and installment sale.
- Like a private annuity, the payments end at your passing, and like an installment sale, the obligation can be secured with a note or collateral without jeopardizing the tax treatment.
- Buy-Sell Agreement – These agreements let you arrange the terms of the sale today for a sale later. You can lay all the groundwork for the sale at a time when there is no pressure to sell.
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- Buy-sell agreements can be structured to provide potential buyers through the use of options or guaranteed buyers through purchase obligation clauses.
- Coordinating the Sale with Gifts – It is possible to coordinate the sale of your business with a gifting program to reduce potential estate taxes.
- Gifting allows you to systematically reduce the size of your estate.
- When you make gifts of portions of your business interest, you can still maintain control of the business until you are ready to fully let go.
- This strategy can provide you with the opportunity to ease your successor into the business by granting smaller ownership portions up until the time of sale.
Conclusion
There are plenty of reasons you might want to sell your business to a family member, and plenty more pros and cons to doing so. Given how complex it is, it can help to have someone knowledgeable to advise you on the best path forward.
As experienced financial professionals, we help clients like you figure out the best retirement plan for their situation, so that when they’re ready, they can retire gracefully with peace of mind.
Please connect with us and let us help you plan for your dream retirement. We would be delighted to go on the journey with you.
