When you started your business you probably envisioned your child(ren) taking over the reins of your largest asset one day.
But, according to Business Week, just 40% of businesses reach the second generation. Maybe that’s because no family member wants to take over or maybe it’s because business owners can’t decide how to treat children that are in the business versus out of the business.
If you only have one child, then it’s complicated enough on whether you sell or gift business interests, and when. If you have more than one child, especially some in the business and out of the business, it is particularly hard to treat them fairly.
In this article, we’ll explore selling vs. gifting your business, how it will benefit you and your children, all so you can decide your next course of action in planning for your succession.
Selling vs. Gifting Your Business
Most owners will begin with the thought of, “I want to sell my business to my son or daughter.” And that’s great. However, this approach means you’ll be paying additional income tax to make that happen. Occurring these additional taxes seems odd since your business was likely going to lead to them one day, anyways, right?
For example, if your business is worth $10M, and you were set on selling your children the business for $10M, then your children owe you that at closing or over time in what is known as a seller’s note. Since children generally don’t have enough cash on hand to buy your business at closing, the children generally purchase the business over a period of say 10 years using this seller’s note. Basically, it’s a big IOU. And you know far too much when it comes to IOU’s and your children.
To repay that $10M seller’s note a few taxes have to be paid over time:
Income tax on the earnings
Your children would have to earn $15M of profit over the seller’s notes duration, and assuming a 33% tax bracket, they’d net $10M on an after tax basis. They’d take all of this $10M and repay you. The duration of time that you allow for your seller’s note really controls how quickly they provide you the money, so a longer time period would loosen up free dollars for them to pay you longer and direct more money to them for lifestyle.
Capital gains taxes are due by you
As you receive the 10M of funds from your children, more taxes are due. Likely, your tax basis in your business is near zero, and so when you sell your company to anyone, including your children, you would owe capital gains taxes on the proceeds. These taxes might be due immediately at closing, or they may be due over the term of a seller’s note. Either way, they are due. Assuming 25% in capital gains taxes, this might be another $2.5M of taxes on the same $10M transaction. The same transaction.
So out of the $10M of business changing hands in a sale, it might cost $5M of taxes paid by your children (the buyers), and another $2.5M of taxes paid by the seller. Wow.
Selling your business to a child often means 2 layers of tax.
And that’s just something all business owners want to avoid…right?
For tax planning purposes, gifting your stock rather than selling your stock just makes sense.
This gifting can be done over the same schedule as a sale would be. Your child(ren) would pay you deferred compensation from the business. Meaning both parties would agree on how much will be paid out until when, essentially giving Dad or Mom a paycheck from the business.
Both the buyer (children) and seller (you) would have achieved the end goal:
- Getting money out of the business, AND
- Transferring the business to the next generation
Gifting Is Not A Taxable Event, But Gifting May Not Seem Fair
Oftentimes, business owners have a hard time wrapping their head around the idea of a gift. Especially if there are several children involved and maybe only one child is being gifted the business. If a business owner gifts some or all of their stock to one child, but no stock to other children, the children not receiving ‘the gift’ might be resentful.
Even if you as Mom or Dad feel it’s fair to reward a hard-working child in the business with a gift of stock, the children not in business in the same capacity often feel slighted. Conversely, if you decided to give each of your children the same gift of stock, the hard-working child in the business often feels slighted.
Many owners struggle with how to deal with fairness when gifting business stock.
That said, gifting is an incredibly tax efficient way to transfer stock to a child. We just learned that selling a business creates unexpected taxes, and is an onerous way to transfer a business.
Using a gift of stock made in 2024 as an example, a business owner can gift $13.61M of business stock to a child without paying:
- Income taxes
- Capital gains, or
- Gift taxes
Yes, there can be taxes on a gift if you don’t approach this the right way.
If a married couple BOTH gifted business stock, then we can double that number for 2024 to nearly $27.22M of stock that is transferable on a relatively tax free basis.
Of course, the business stock is off your balance sheet as a parent, and now on your child’s balance sheet. If you had sold the business stock to your child, you would have received monies back at closing or over the life of the seller’s note. While taxes are lower with the gift, you simply don’t have the same assets on your balance sheet to retire either.
Owners selling to children should make very sure that a gift of business stock leaves enough other assets for you as the owner to retire with.
As long as you can ensure you have enough assets to retire by gifting the business the same way you would as selling, there are many benefits of gifting the stock. This includes:
- Tax efficiencies when compared to selling stock, and
- Less risk for the buyer (your son or daughter) since there isn’t a seller’s note
Is Gifting Right For Your Succession Plan?
As a business owner, we know that you’re concerned about your financial well-being after the sale of your business. But, how can you know what course of action is right for your largest asset?
While gifting your stock, rather than selling, has many benefits, including tax efficiencies and less risk to your children as the buyer, there are some other aspects to consider for your succession. Gifting your business does in fact:
- Remove retirement assets and income from your balance sheet, and
- Can be difficult in terms of fairness to your buyer (children)
Gifting is ideal for your child that is IN the business and wants to run the business. Now, that’s not to say that your child(ren) can’t be involved in the profitability of the business but in that instance, selling does make more sense for the best interest of your succession plans and a robust retirement.
While the gifting strategy doesn’t require much time to set up, it’s always best to begin planning 5-7 years before you hope to exit your business.
If you’re thinking about selling your business, talk with an experienced business planning advisor at Consolidated Planning to start paving the right roadmap for you.
2024-167637 Exp. 1/2026
Guardian, its subsidiaries, agents and employees do not provide tax, legal, or accounting advice. Consult your tax, legal, or accounting professional regarding your individual situation. The information provided is based on our general understanding of the subject matter discussed and is for informational purposes only.
This material contains the current opinions of Neal Brincefield and Consolidated Planning only. These are not the opinions of Park Avenue Securities, Guardian, or its subsidiaries.
