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Exit Strategies in Estate Planning & Pertinent Tax Issues

Sale of Stock or Assets.

Stock.  A stock sale is simpler than an asset sale, and will result in one level of tax to the selling shareholders of a C-corporation.  With an S-corporation that does not have C-corporation earnings and profits, or in the case of an unincorporated business treated as a partnership for federal income tax purposes, the tax consequences are the same regardless of whether interests in the entity or the assets are sold.  However, purchasers are more interested in buying assets than stock or the ownership interests of an unincorporated business because of potential contingent liabilities that would remain with the business.

Assets.  Selling a company’s assets generally results in two levels of tax if the business is a C-corporation.  In contrast, if the business is in an S-corporation, a partnership, or a limited liability company (“LLC”) treated as a partnership for tax purposes, there will be only one level of tax on the unrealized appreciation.

Tax-Deferred Reorganizations. 

In some cases, it may be possible to engage in a tax-deferred reorganization.  One possibility is to divide a business in a tax-free division (See IRC §355).  This may be useful when there are sibling rivalries but the siblings are interested in participating in the business.

Dividing a business into two or more separate entities may allow the founder to pass ownership in a particular business to children interested in participating in that business.  At the end of the day, the children interested in a particular business would not have ownership interests in the other businesses, thereby minimizing potential conflicts.

Sale to an ESOP. 

In certain circumstances, a sale to an ESOP may carry out the income tax objectives of the founder, particularly where a benefit of the tax-free rollover of the sale proceeds is possible.  However, the family must be willing to have a “non-family member” shareholder — the ESOP.  The benefits of an ESOP are illustrated in Appendix A, Example 6.

Sale to Key Employees.

Selling the owner’s interest to key employees may be appropriate when there are no family members who are interested in or capable of taking over the management.  This strategy will only work if the key employees are able financially to buy the business.

Sale to Family Members. 

A sale to family members will usually incur taxable gain, which may not be palatable to the current owners.  However, a sale may be a way to treat children equally when not all of them are active in the business.  In this regard, a sale to a grantor trust in which the active family members are beneficiaries of the trust would avoid recognizing gain upon the sale (but the beneficiaries would receive a carryover basis).  The sale to a grantor trust technique is illustrated in Appendix A, Example 7.

Bequest. 

Possibly the simplest way to dispose of the business is to leave the ownership to one or more family members.  Here, the issues here will be (i) payment of the estate tax with respect to the business interest if not all of the decedent’s children are receiving interests, and (ii) treating the “other” children fairly.

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