"I would rather expire at my desk than to sell my enterprise and pay Uncle Sam one dime in taxes." How many owners that have paid their fair share of taxes for twenty years of construction their enterprise feel this way? The tax bite is the particular biggest factor in an owner's reluctance to sell his/her company.
I have previously written articles discussing assorted aspects of transaction structures to minimize taxes. As a result, I am often contacted by a panicked distributor that is a week from closing his enterprise sale as he looks in disbelief at his accountant's spreadsheet detailing the tax burden of his impending sale.
Recently, the distributor of a Sub chapter S Corporation with an million transaction value contacted me. The tax basis was below 0,000 and million of the transaction value was the assumption of debt. When the dust settled, he was finding at a capital gains tax liability of a improbable 5,000 while only receiving the remainder of proceeds after the assumption of debt. The assumption of debt is thought about as part of the capital gain for tax purposes.
The owner sent his accountant's spreadsheet to me and since I am not a tax accountant, I sent it to my tax wizard at Bdo Seidman. He found a few small tweaks, but said that there was not much that could be done from an accounting standpoint for this owner. When I reported this back to the distributor I could feel his frustration and frustration.
So I began my quest for a good solution. After some dozen phone calls to my professional network, I was directed to a microscopic known vehicle called a inexpressive Annuity Trust. This vehicle has passed the scrutiny of the Irs and the Tax Court. It is not a way to avoid the cost of taxes, rather a recipe of deferring them with vast economic benefit to the owner's beneficiaries.
Below is a simplified description of the process. As the owner contemplates the sale of his enterprise (or any very appreciated asset for that matter) he "sells" it to a trust Prior to its greatest sale. This trust purchases the asset at Fmv and exchanges an annuity cost stream perfect with Irs life expectancy tables and interest rates. The trust then sells the enterprise to the buyer to fund the annuity.
The transaction is accompanied by a gift to the trust in the amount of 7% of the face value of the annuity. This is so it qualifies as a trust by creating an entity with economic value. Remember, the inexpressive annuity is viewed as having zero economic value because the asset minus the obligation theoretically equals zero.
The trust is in the name of the owner's beneficiaries and all aspects of the trust are controlled by the trustees/beneficiaries and not by the owner. The trust for the benefit of the heirs owns the assets and owns the annuity cost obligation. The trust can be structured to defer the annuity payments for a period of time to coincide with the owner's need to receive these payments, lets say, for example, ten years while those ten years the trust's investments or a industrial annuity grow without incurring a tax bite for the enterprise sale.
When the annuity payments start, the owner is taxed at his then current tax rate for the measure of the annuity cost attributable to the capital gains, his basis (no tax), and depreciation recapture from the sale, and the revenue produced from the annuity. The annuity pays the owner and spouse this annuity cost until last to die or until the annuity investments run out. If the owner and spouse die, any remaining assets are transferred to the beneficiaries face of estate tax liability.
If your investments accomplish at the rate used in the annuity calculation and the last to die lives to their exact life expectancy, theoretically the trust value will be anyone the gift measure (7% of the selling price) has grown to. However, if the investments do very well and you outlive the life expectancy tables, you could receive payments well in excess of the former annuity face value. Those excess payments would be taxed at your then current revenue tax rate.
If the investments do well and the value grows above the required annuity withhold amount, the excess can be distributed to the beneficiaries as income.
In the simplest of views, this acts like an Ira. You are not currently taxed on the amount you put in, it grows tax deferred and you pay taxes upon distribution, hopefully at a far more convenient tax rate. In the case of the frustrated distributor from above, what if he deferred all payments by ten years on the full sale price and the 5,000 in capital gain taxes owed? He had a life expectancy of 20 years beyond the start of the distributions. The 5,000 that he did not pay in taxes grows at 7% to ,939,323 by the time distributions start.
Every annuity cost contains a measure of the capital gain or 1/20th of the total capital gain annually. Therefore, the bulk of the resulting speculation value of the capital gains tax deferral provides huge returns for years to come.
If it seems too good to be true, remember it is tax deferral and not tax avoidance. The owner has sold his enterprise first to the trust in return for an annuity cost stream. The owner cannot control the trust. To the extent that the owner wants immediate access to some of the sales proceeds, he would pay all taxes in proportion to the amount he is receiving. In cases like the one above, this tax deferral tool can have a dramatic impact on the financial status of the owner and his heirs by allowing the tax deferred funds to blend for many years before their greatest distribution and the cost of any tax.
Selling Your firm - A Tool To cut Capital Gains Taxes
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