Denha & Associates, PLLC Blog

Pre-Transaction Planning-When Is It Too Late To Make That Gift?

By: Randall A. Denha, J.D., LL.M.

As I’ve discussed in previous articles on the sale of a business, one can never begin the process of planning too early.  Often, however, many are too late.  They only realize they could have done things differently or structured the transaction, whether at the letter of intent stage or purchase agreement stage, differently and thereby yield a different result. The liquidity event a business owner dreams of may or may not ever materialize, but if it does, it comes very quickly and leaves little time to undertake any pre-transaction planning, sometimes called pre-liquidity planning.

Liquidity events — so called because they may convert illiquid assets to cash or marketable securities — can increase your wealth substantially. With proper planning, the right timing and an experienced team of advisors, you may also mitigate the income and estate tax liability usually associated with a sale of a privately held company.

The reality is, most business owners focus solely on running their business and handling transaction details, leaving personal planning issues to chance. For anyone contemplating the sale of a business, the time to plan is now. As remote as they might seem in the run up to a transaction, the seller’s goals for lifestyle spending, investment, family wealth transfer, charitable giving, and all the related tax issues, need to be considered – and integrated – well in advance. Ideally, the corporate and wealth management advisors will work together. In the heat of the deal, there will be little time for thoughtful planning, but there will be all the time in the world for regret. As such, timing really matters!

Before an owner considers any transfers during his or her lifetime, an important question to ask is: How much is needed, post-sale, to live the lifestyle he or she desires? Owners should be careful that transfers do not jeopardize their ability to satisfy their needs. For owners used to receiving income from their businesses, it is important to plan for that sum’s replacement through reinvestment of sales proceeds.

While resources are spread thin, it’s easy for attention and concern for personal finances to fall by the wayside. Pre-liquidity planning addresses these important considerations and defines end goals early in the process. In the book, The Seven Habits of Highly Effective People, best-selling author Steven Covey advocates as Habit #2 to “Begin with the End in Mind”. Just as a business owner should plan ahead for the future of their business, so too should they plan ahead for their personal finances. Seizing the opportunity and beginning with the end in mind is precisely the objective of pre-liquidity planning.

With proper planning. all goals are defined and understood early in the process, encompassing any potential increases in discretionary spending, general living expenses, and lump sum cash requirements that are anticipated as a result of the successful liquidity event.

For owners interested in transferring wealth to family members, there are many different gifting options available. Depending on the individual’s goals and strategies, gifts can take a number of forms. As of 2017, the IRS allows each individual to gift up to $14,000/$28,000 (if married and spouse consents) per beneficiary, per year without incurring gift taxes or using up any portion of one’s lifetime exclusion amount ($5,490,000). When gifts are given within the annual exemption amounts, a gift tax is avoided. For larger gifts above the $14,000/$28,000 per person threshold, a portion of the lifetime exclusion can be applied to avoid current gift taxes, however this will deplete the available lifetime exclusion amount available for additional planning at a later date. Once a gift has left the donor’s estate, future appreciation on the stock accrues on behalf of the recipient, more often than not, the younger generation. This is an important part of the pre-liquidity planning process because a low cost basis allows one to transfer a greater number of shares using the annual and lifetime exclusions noted above. Therefore, this gives the grantor the ability to shift a greater value to the next generation. The anticipated rapid increase in value after the deal is finalized would occur outside the grantor’s estate.

The question commonly asked to me by a client embarking on a sale of the business is: Is it too late to transfer some of the business to my beneficiary (or a trust for such beneficiary?) Well, this answer has been provided through some guidance by our IRS and the Courts. The recognized authority suggests that the donor should be held to have undertaken a pre-arranged sale (resulting in recognition of gain on sale) only if the donor is under a legally binding obligation to sell at the time of the transfer.  Is there a signed letter of intent?  Are the parties still negotiating the letter of intent?  Have the parties fully executed a formal purchase and sale agreement?  If not, make the gift as it’s not too late!