The transition from building a business to enjoying retirement is a major milestone requiring planning and careful execution. Adding succession planning, business valuation, tax strategy, and estate planning significantly to one’s tasks is necessary.
An experienced estate planning attorney is the right choice for an impartial sounding board and knowledgeable expert when approaching these hurdles. A comprehensive estate plan can encompass proceeds from the sale of a business as well as savings from a life of hard work.
Succession Planning: Start Early and Document It
A succession plan, which installs a new owner and/or leader for a business, cannot be planned too early. Most experts suggest starting on it between five and ten years before retiring, regardless of who will take over.
Along with naming the new business leader, a succession plan should cover key financial points, such as:
- Projected company growth
- Business valuation
- Tax issues
- Legal components of the business like buy-sell agreements and powers of attorney
Get the Business Valued by a Professional
Have a business appraiser determine the accurate value of the company before negotiating any terms of transfer. This is the cornerstone of the succession strategy. A professional appraisal that follows IRS guidelines reduces the risk of disputes when an estate is settled.
The three valuation approaches that the IRS recognizes are:
- The market approach, which uses the selling prices of similar businesses
- The asset approach, which tallies the company’s tangible assets
- The income approach, which focuses on expected economic rewards and risk level
Your Buy-Sell Agreement: Establish or Update It
A buy-sell agreement is a foundational document of any business with multiple owners. Often funded by life insurance policies, it’s the contract among co-owners that establishes the terms for transferring ownership interests when specific events occur, such as a disability, death, or retirement.
Buy-sell agreements establish the value of the business for gift and estate tax purposes (under specific requirements), carrying significant tax implications. With the valuation in place, an estate plan can be made that reduces the risk of valuation disputes or IRS challenges. Remember, the valuations must be realistic, as the IRS will only respect the agreed price if it does not undervalue the business for tax avoidance.
Illinois’s Estate Tax Cliff and How to Avoid It
Few states impose their own estate tax, and Illinois’s is particularly onerous. There is a $4 million threshold for exceptions, a figure commonly exceeded when real estate, investment accounts, life insurance, and retirement savings are tallied up.
Additionally, Illinois estate law is called a “cliff” structure because Illinois’s exemption is a threshold, not a credit. Estates valued above the $4 million threshold are taxed in their entirety, not just the portion that exceeds $4 million.
An additional complication for married couples is, spouses may not combine their exemptions. For those at or above the state threshold, revocable living trusts with Illinois specific estate tax provisions or a credit shelter trust triggered at the death of the first spouse are necessary to shield estates from high taxes.
Retirement Income Exception Can Produce Savings
Retirees in Illinois do not pay state income tax on their pensions, qualified retirement plan distributions, or Social Security benefits, producing significant savings. This also provides a strong incentive to direct savings to applicable accounts. Unfortunately, proceeds from the sale of a business remain taxable, including under federal capital gains laws.
Update Beneficiary Designations and Estate Documents
Estate planning often coincides with retirement and succession planning. Designated beneficiaries should be reviewed periodically to ensure they align with current family circumstances. A comprehensive estate plan also requires reviews of business ownership interests, life insurance policies, and retirement accounts.
Navigating the Legal and Financial Hurdles
Illinois-based business succession planning requires overlapping layers of state and federal law. Knowledge of the Secure Act is of particular importance for business owners as the rules governing inherited retirement accounts have changed. An experienced estate planning and business attorney from Legacy & Life Law can create a retirement plan that provides the financial benefits you have worked for. Call for a consultation today.