Arranging to hand over the business and establishing a sound succession plan is
beneficial for most c-store business owners.
By Mark Battersby, Contributing Editor
For those who own a closely-held or family convenience store business, retirement can be anticipated and expected, or the unexpected result of illness or other events.
In addition to ensuring there will be enough money to retire, c-store owners, shareholders and partners must ensure any unanticipated exit doesn’t leave them high and dry.
While for many, retirement may appear as a distant speck on the horizon, planning to hand over the business and establishing a sound succession plan is beneficial for most c-store business owners and absolutely necessary in the event of something unanticipated. At its most basic, a succession plan is a documented road map to be followed in the event of the owner, partner or shareholder’s death, disability or retirement.
A key component of every plan is the estate tax. However, while the current estate tax is a whopping 40%, thanks to the Tax Cuts and Jobs Act enacted in 2018, the amount that can be ignored or excluded from that tax computation is $11.18 million ($10 million adjusted for inflation).
Leaving an estate of $15 million in 2018 and not having given any taxable gifts, mean only $3.82 million will be subject to that 40% estate tax. What’s more, the estate exclusion is per person not per couple.
Obviously, in order to predict the potential bite of estate taxes, it’s necessary to know what the c-store business is worth. Fortunately, there are a number of methods for calculating the value of a business, methods that may or may not reflect the reality of the marketplace or be acceptable to the IRS.
Once a dollar value for the business has been determined, usually by a qualified appraiser, life insurance can be purchased on all of those involved in the business. Then, in the event that a partner or shareholder passes on, the insurance proceeds will be used to buy out the deceased partner or shareholder’s interest in the business and distribute it equally among those remaining.
Insurance can also be used to finance two basic arrangements used by many c-store owners, partners and shareholders known as “cross-purchase agreements” and “entity-purchase agreements.” While both ultimately serve the same purpose, they are used in different situations.
Cross-purchase agreements are structured so each partner buys and owns a policy on each of the other partners in the business. Each partner functions as both owner and beneficiary on the same policy, with each other partner being the insured; therefore, when one partner dies, the face value of each policy on the deceased partner is paid out to the survivors, who will then use the policy proceeds to buy the deceased partner’s share of the business at a previously agreed-upon price.
With a far less complicated entity-purchase agreement the c-store business itself purchases a single policy on each partner and becomes both the policy owner and beneficiary. Upon the death of any partner or owner, the business will use the policy proceeds to purchase the deceased person’s share of the business. The cost of each policy is generally deductible by the business.
There are a number of strategies for exiting a convenience store business. One strategy, the Family Limited Partnership (FLP) has, over the years, proven itself an extremely valuable tool for both succession and estate planning. After all, what other tool can ease or even eliminate the tax bite often associated with transferring the c-store business—or its income—to family members, all the while keeping the owner’s current tax bills to a minimum?
Typically, a FLP is formed by the older generation, usually the parents, who contribute assets to the partnership in return for both general partnership units and limited partnership units. The parents can then embark on a plan of giving unlimited partnership units to their children and grandchildren while retaining the general partnership units that actually control the partnership.
Thus, the parents might retain control of the business; draw a salary or wages from it, all the while sharing the profits with other family members who are taxed on those profits at a tax rate that is usually lower than that of the parents/owners.
Selling the c-store business to its employees using an Employee Stock Ownership Plan (ESOP) allows the sale proceeds to be rolled over on a tax-deferred basis. In addition to being an excellent exit strategy with significant tax savings for the owners, shareholders and partners, ESOPs are great for motivating and rewarding employees, and for taking advantage of incentives to borrow money for acquiring new assets in pretax dollars.
The ESOP can borrow money to buy out the owner’s stake in the business. If, after the stock purchase, the ESOP holds more than 30% of the business’s shares, the owner can defer capital-gains taxes by investing the proceeds in Qualified Replacement Property (QRP) such as stocks, bonds and certain retirement accounts to help provide income during retirement.
A buy-sell agreement, often called a “business prenup” is a legal contract that prearranges the sale of a business interest between a seller and a willing buyer. A buy-sell agreement allows the seller to keep control of his or her interest until an event specified in the agreement occurs, such as the seller’s retirement, disability or death. Other events such as divorce can also be included as triggering events under a buy-sell agreement.
The time to sell is optional—now, at retirement, at death, or anytime in between. As long as the sale is for the full fair market value (FMV) of the business, it isn’t subject to gift tax or estate tax. Of course, a sale that occurs before the seller’s death may be subject to capital gains tax.
Where does the succession planning process start? The first step involves clearly establishing the c-store owner/shareholder/partner’s goals and objectives, keeping in mind the operation’s current human and financial resources.
Other questions might include the following: How much control of the business is desirable? Is there someone capable of running the business once you step down? Are there key employees who must be retained? Are there sufficient assets to pay the estate tax, equalize the estate and keep the business? How much money is needed to reach the owner’s financial goals?
And don’t forget: While clarifying those goals and wishes is important, it’s not enough. The business owner also needs to communicate his or her vision with family, business partners and key employees.
Developing a succession plan is a multi-phase process outlining, in detail the, who, what, when, why and how changes in ownership and management of the c-store business is to be executed. At a minimum, a good plan should help accomplish the following:
• Transfer control according to the wishes of the operation’s owner, shareholder or partner;
• Carry out the succession of the business in an orderly fashion;
• Minimize the tax liability of all involved;
• Provide economic well-being after the owner, partner or shareholder steps aside.
Obviously, business owners seeking a smooth and equitable transition of their interests should seek competent, experienced advisors to assist them in this matter. After all, the taxes saved may be yours or your heirs’.