07 Aug 2015 Selling Your Business to Your Child
Family-owned businesses are often staples of their communities. For many owners of these types of businesses, it is desirable to sell the business to their child. This is particularly true if the child is involved in the operation of the business. Further, by selling the business, as opposed to gifting it or placing it in a will, it is possible to avoid estate and gift taxes.
Setting Up a Sale
An owner of a profitable business likely dedicated a great deal of time and effort in creating the business. By passing the business on, the owner can provide a source of income and employment to a child while keeping the business within the family, which is often important to a creator of a successful business. Furthermore, it may be important to an owner that the business continues to be operated in a certain way. Often, this can be accomplished by keeping the business within the family, as it is more likely that a family member will comport with the wishes of the owner.
Because owners would often prefer to simply gift or pass by inheritance the business onto their child, but also wish to avoid tax implications, it is likely that a sale to a child is done under favorable terms. A sale may take the form of an initial down payment, with a fixed, low interest rate over a long period of time (like 20 years), and a balloon payment at the end of the loan. A balloon payment is simply a very large payment that is paid at the conclusion of a loan.
If the business is profitable enough, the child will have the ability to make the interest payments and set aside money for the balloon payment. When the loan comes to an end, the child assumes ownership of the business. The arrangement allows a child to acquire the business through funds generated by the business. At the same time, the family avoids having to pay gift or inheritance tax on the transfer.
It is important for business owners who are interested in selling their business in this manner to be aware of the Applicable Federal Rate (AFR). The AFR is a table that is published monthly which sets the minimum a loan rate must be in order to avoid the loan being considered a gift subject to tax. This is important because parents selling their business to their child often want to do so under the most favorable terms. But, if the loan interest rate is too low, it may appear to the IRS as a gift.
This type of purchase arrangement, in part, depends on the interest rate being low enough. As the minimum interest rate to avoid classification as a gift increases, the more profitable the business must be. Otherwise, the purchaser may not be able to make the interest payment and save enough for the balloon payment.
Help With Your Business
The above is just one of the many ways in which an individual can transfer ownership of his or her business to a child. For more information on this and other options, speak with an experienced tax law attorney today. At the Royse Law Firm, we use our specialized expertise to provide help with tax-efficient business succession planning.Disclaimer: This blog and website are public sources of general information concerning our firm and its lawyers, as well as the information presented. They are intended, but not promised or guaranteed, to be correct, complete, and up-to-date as of the date posted. This blog and website are not intended to be, and are not, sources of legal opinion or advice. The materials, information, and communications on this blog and website do not apply to any particular person, entity, or situation, and do not apply to you or to your specific situation. You will need to consult with an attorney and/or other appropriate professional about your specific situation. Thank you.