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Oxford Financial Group, LTD


Oxford Financial Group, LTD


Expert Perspective

News, research and market insights from our team of experts.


Current Issue | December 20, 2018

Impact of Pre-Transfer Estate Planning When Selling a Business

By: Julia Weaver, J.D., Director, Family Office Services and The Trust Company of Oxford and
J.P. Simmons, CFP®, CLU®, Director, Practice Management

For many business owners considering a sale of their business, maximizing enterprise value becomes a singular focus and the proverbial finish line. Beyond the finish line, however, is the looming reality of the tax haircut this enhanced wealth may face when it passes to heirs. Additional issues around how the family will meet its objectives with the “new” balance sheet must also be considered.

Let’s start with taxes.

By transferring a portion of their business interest into structures that will avoid gift or estate tax, sellers may retain a significantly greater percentage of this growth in their family’s wealth.

The Three Deltas

Delta One: Avoiding Tax on Valuation Discounts
Creating discounted interest can greatly enhance tax savings. Discounts are typically available for minority non-voting and non-marketable interests, which can generally be created through a fairly simple recapitalization process. Rather than passing only $5.49 million of non-discounted interest with the current $5.49 million estate and gift tax exemption, it is far better to transfer that same interest at a value that is reduced by a 30% valuation discount. When the business interest is later sold, the discount evaporates and all shares receive the per-share sale price. In this scenario, $7.8 million of post-sale value has been “squeezed” through the $5.49 million exemption funnel. This is referred to as “freezing the discount”.i

Delta Two: Avoiding Transfer Tax on the Investment Banker’s Premium
Future appreciation, or the “pop” in value many business owners enjoy as a result of a successful sales process, may also be structured to occur outside of the taxable estate, further enhancing the retention of family wealth.

As is now common knowledge, there is currently a proposal for the repeal of the federal estate tax. Any such proposals must go through the legislative process prior to enactment. Additionally, a repeal of the estate tax may be replaced with a different type of death tax, to wit: a recognition of capital gains upon death. This could result in continued death tax exposure of up to 20% on appreciated assets, certainly worthy of ongoing strategic planning.

Delta Three: Avoiding Transfer Tax on Appreciating Net Worth Post–Sale
After the liquidity event, this newly monetized wealth can remain in tax-advantaged vehicles that will continue to protect subsequent growth from estate taxation. Over the future years of wealth accumulation, the potential tax savings can be staggering.

The Tax Impact: A tale of two sellers.

We assume two sellers who are in a highly fictional identical situation but for the fact that Seller One (Sally) was referred by her Investment Banker to her wealth planning team for pre-transfer planning. Seller Two (Sam) was not. Both businesses were originally valued at $30 million (the “base” value) and each concluded a very successful sales process with a rapid increase in enterprise value. Both businesses were sold in three years for $60 million.


  • The net proceeds attributable to this increased enterprise value (the “sale premium”), after taxes and costs, was $20 million.
  • Both sellers have a level of wealth that subjects them to federal estate tax.
  • Three years prior to the sale, Sally implemented a strategy to remove a 25% minority non-voting interest from her taxable estate, retaining full control of the business.

The Strategy:

  • Sally's advisors crunched the numbers and began with a recapitalization of Sally’s interest into voting and non-voting shares.
  • After properly capitalizing a trust that is excluded from estate taxation (known as an Intentionally Defective Grantor Trust, or “IDGT”), Sally sold a 25% discounted minority interest to the IDGT in return for a $5.25 million interest-only balloon note (the amount of the originally discounted value of her interest)ii.
  • The note was crafted with the appropriate mid-term Applicable Federal Rate and other arms-length features.
  • The “sale” avoided triggering any capital gains due to a properly structured IDGT and terms of the sale.

Financial life after the business is monetized.

How will the family meet its objectives with the new balance sheet? With the liquidation of what is typically the primary asset of a business owner’s family, the necessity to manage objectives, income and risk becomes paramount. Many families are challenged to successfully navigate the change and sustain wealth across generations. To be prepared, careful financial modeling and testing is needed. The following basic elements of a plan should be considered well in advance of the sale of the business:

  • Define objectives with realistic values and growth expectations taken into consideration.
  • Determine the appropriate size of a safety net for the family.
  • Design a strategy to support and continue the lifestyle of family members.
  • Identify aspirational objectives and generational intentions.

Unique Times / Unique Situations.

As with all elements of planning, pre-transfer planning should be done in coordination with the business owner’s comprehensive estate plan, particularly in this present time of uncertainty as to our future estate tax regime. When appropriate to meet the core goals and objectives of the business owner, pre-transfer planning can have a significant impact on the family’s enduring wealth. Your Oxford team of advisors can assist in determining the proper strategy for each client’s unique situation.

i There is currently a proposed Regulation that may limit the Section 2704 valuation discounts on certain family-owned discounts. iiSummary of sale to IDGT transaction – key considerations:
No gain recognized on sale but the IDGT assumes grantor’s basis in assets.
Trust issues a low interest rate (AFR) promissory note to the grantor.
Trust uses its assets to pay interest and principal on the note; interest is neither deductible by the trust nor included as income to the grantor.
The grantor pays income tax on trust income.
Thus grantor’s estate is further reduced by the tax payments (referred to as “tax burn”), and appreciation on the trust assets not reduced by income taxes.
Promissory note will be included in the grantor’s estate if still outstanding at the grantor’s death.

The above commentary represents the opinion of the authors as of 3.16.17 and is subject to change at any time due to market or economic conditions or other factors. This information is not intended to serve as tax or legal advice. As always, tax and legal counsel should be engaged before taking any action.