Key takeaways

  • Family business succession planning can feel overwhelming, but it’s a critical activity if you want the company to endure for generations.

  • If you want to shift ownership to one or more of your family members, a variety of strategies can be used to make a transfer.

  • Transition options that potentially minimize the tax impact include using a gifting strategy and establishing a trust to avoid transfer taxes.

When you started your business, you envisioned it enduring for generations. And it can—but family business longevity relies on you developing smart business transition strategies now.

Even if you’ve worked through the myriad personal and professional issues that can arise during the eventual handoff, the best-laid plans may fail if you don’t consider transition tax issues. This is because there are strict rules preventing family businesses from being used as tax-exempt wealth-transfer vehicles. 

“[Family business owners] tend to ignore succession planning until it’s staring them right in the face.” 

James McBain, west regional director for Wealth Planning and Trust Advisory,

U.S. Bank Private Wealth Management

Succession planning not only helps family-owned entities address tax-related issues; it also helps them identify qualified individuals who can move into key roles, avoid business disruption and maintain a competitive edge.


Two-thirds of family businesses lack transition plans

If you haven’t laid out a succession plan for your family business yet, you’re not alone. In fact, just 34% of U.S. family businesses surveyed by PwC say that they have robust, documented and communicated succession plans in place.

There are a few reasons why two-thirds of family businesses lack business transition plans. It could be dread of an awkward conversation, a CEO who’s reluctant to step down or a lack of an heir apparent.

A lack of hours in the day is also to blame, in some cases. “Owners allocate much of their time, talent and resources to running the day-to-day business, which is very closely tied to their identities,” explains James McBain, west regional director for Wealth Planning and Trust Advisory with U.S. Bank Private Wealth Management. “As a result, they tend to ignore succession planning until it’s staring them right in the face.”

At that point, it can be challenging to conduct any meaningful level of family business transition planning, which McBain says should begin five to 10 years before the owner plans to exit the business. 


The elements of a family business succession plan

Once a family business decides to undertake succession planning, the plan itself should address questions such as:

  • Who is going to own the business?
  • Who is going to operate the business?
  • What family dynamics should be factored into the plan? (For example, being fair and equal; not leaving any siblings out of the process; and including in-laws as potential leaders)
  • How will the transition affect the family’s financial and tax picture?

In many cases, family business owners focus on the transfer tax issues, which may include gift and estate taxes and generation-skipping transfer taxes. If ownership is being transferred to children, grandchildren and/or current managers, there will also be income tax implications to consider (in other words, who will pay tax on the business’ income). Capital gains tax will also come into play if company stock is being transferred to a family member who then sells that stock.


Strategies for minimizing family business succession taxes

There’s a lot that goes into a good succession plan, with taxation being the primary concern for family business owners who want to alleviate the financial burden on themselves and the next generation of company leaders. Here are three strategies to consider:

1. Create a parallel business.

Instead of handing over a fully functioning and highly profitable company and the tax burden that comes with it, consider seeding new businesses in your heirs’ names. These startups can be linked to the core business and its clientele, without the overhead and assets of the original company. For example, instead of having your company develop and launch a new product, you could launch the product under your heir’s name. That way, the parallel business has the chance to develop significant long-term value long before it’s ready to be handed off to the next generation.

2. Use a gifting strategy, one piece at a time.

Small business owners can leverage the annual gift tax exclusion (currently $18,000, or $36,000 per married couple) to transfer ownership over time. Owners can use this one-time tax exemption to gift interest in the business to heirs while the business value is still low enough to meet exemption limits. The current estate tax exemption limits are $13.61 million per individual and $27.22 million for a married couple filing jointly. It’s important to note that these limits are set to expire at the end of 2025.

3. Intentionally Defective Grantor Trust (IDGT)

The IDGT takes advantage of estate tax exemptions to avoid taxes on the transfer of the business. It also removes future appreciation from the business owner’s estate and hands that value to the next generation. The IDGT also allows future generations to avoid generation-skipping transfer taxes—which kick in when you transfer assets to recipients who are two or more generations below you—but only if ownership stays within the trust. McBain sees the IDGT as an especially good succession planning tool because it allows for long-term planning. “The trust structure supports multi-generational planning by allowing owners to consider the company’s future ownership and management, while also staying very focused and intentional about future tax structures,” he says.


How to move past family business succession planning pitfalls

Family dynamics, tax requirements and the fear of relinquishing control can all send family business owners running to the hills when the words “succession planning” are uttered. It can feel overwhelming, but it’s achievable if you break down the process.

Start small by writing down your family business transition goals and objectives, and then work your way up from there. Consider which family members would (or wouldn’t) like to be involved in the process, the roles that they can play in the family business and which of them can fill operational roles versus just serving as owners.

“Focus on what you own and what it’s worth, understand the corporate structure and factor in any potential business growth over the next 10 years,” says McBain. That last point is especially important if a company is in high-growth mode and whose family business owners can take steps now to plan for a larger ownership transfer when the time comes.

For example, McBain worked with one husband-and-wife team that kicked off the succession planning exercise by writing down everything about the company that was most important to them. Then, they looked at what they wanted to accomplish with their family business succession plan. Questions they addressed included: What do we own and what is it worth? Why are we starting this planning process now? Are our thoughts and feelings aligned on these matters?

McBain then helped the couple design an estate plan that addressed all taxation issues, the company’s future ownership structure and voting control, family dynamics, and other important factors.

“As a result of this early planning, the transition went quite well for the next generation of family owners,” he says. “The founders now feel really good about their company’s position for the future.”

Learn how we can help you work toward your business and personal financial goals.

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