Business succession planning - CFP Retirement Savings and Income Planning

Business succession planning

Transferring a business at retirement or death: buy-sell agreements, sales to family or employees, ESOPs, valuation methods, installment and gifting strategies, and the income and estate tax consequences of each route for the owner and successors.

Buy-sell agreementsEmployee stock ownership plans

Practice question for this objective

Free sampleRetirement Savings and Income Planningmedium

Maeve, aged 71, owns 60 percent of a manufacturing company and her two adult sons own the rest. A buy sell agreement signed twelve years ago obliges the sons to buy her shares at death for a fixed total of 2,000,000 dollars, and the figure has never been revisited. An independent valuation now puts the whole company at about 6,000,000 dollars, so her interest is worth far more than the agreed price. Maeve assumes the agreed price will also settle the value reported for federal estate tax. What should her planner advise about the valuation provision?

AReplace the fixed price with an independent appraisal taken at agreed intervals, or a formula the owners must review and re-endorse in writing each year Correct
BLeave the fixed price in place, because an agreement that binds both the estate and the buyers to a stated figure also fixes the value reported for federal estate tax
CLeave the fixed price in place and rely on the executor claiming a discount for lack of marketability, which will bring the reported estate tax value back to the agreed figure
DRaise the fixed price to 6,000,000 dollars for the whole company now and treat that as permanent, since a price agreed at today's fair market value cannot be challenged afterwards

A buy sell price for a family owned interest must be refreshed by appraisal or a reviewed formula to remain credible for estate tax purposes. A buy sell price is respected as the estate tax value only where the arrangement is a bona fide business arrangement, is not a device to pass the business to family members for less than full value, and carries terms comparable to those unrelated parties dealing at arm's length would accept. A fixed figure agreed twelve years ago and never revisited fails on the last two counts once the business has trebled in value, because the effect is to move roughly 1,600,000 dollars of value from the mother to her sons at a price no outside buyer would have accepted. The practical fix is procedural rather than numerical: an appraisal clause with a stated frequency, or a formula tied to earnings or book value that the owners must review and sign each year, so the price tracks the business instead of drifting away from it. Note also that the agreement governs who buys the shares and at what price, and does not remove the interest from the gross estate.

Why A is correct: A mechanism that refreshes the price keeps the family paid what the interest is actually worth and supports the argument that the arrangement is a genuine business agreement on terms unrelated parties would accept.

Why B is wrong: Mutual obligation is one of the conditions usually discussed, but it is not sufficient on its own, and a price agreed between a parent and her children is examined far more closely than one negotiated between unrelated owners.

Why C is wrong: Marketability discounts are real for closely held interests, but they are applied to a properly determined fair market value and cannot be assumed to close a gap of this size created by a price that has not moved for twelve years.

Why D is wrong: Updating the figure to today's value is an improvement, but declaring it permanent simply restarts the same problem, because the company will keep growing and the price will be stale again within a few years.

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Exam traps in Retirement Savings and Income Planning

Answers that look right on this material and are not. Each one is a distractor from a different question in the CFP bank for this domain.

No income arises on exercise, the spread is an alternative minimum tax adjustment, and the employer takes no deduction for the exercise.
Why it is wrong: Every part of this is the treatment of an incentive stock option, which is exactly why it tempts, but Ravi's options are non-qualified, so the spread is taxed at once as ordinary income rather than deferred into the alternative minimum tax.
Wait until required minimum distributions begin, then convert each year's distribution to the Roth account as it is paid, so that the conversion is funded by money he was obliged to take anyway
Why it is wrong: It sounds efficient to recycle a distribution he must take, but a required minimum distribution cannot be converted to a Roth account, and waiting also throws away the low income years that are the whole reason conversions are attractive now.
Contributions to the ABLE account are deductible on her federal return, and the earnings inside the account grow free of tax
Why it is wrong: The tax-free growth half of this is right, which is what makes it attractive, but contributions are made with after-tax money and no federal deduction is available, although a number of states do allow a deduction on the state return.

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