Starting a business is exciting and all-consuming. As an entrepreneur, launching a business, then ramping up growth, is of the utmost concern and focus. As tax consultants, we look at things a little differently.
In our experience, we find that most entrepreneurs are laser-focused on growth, and understandably so. They are focused on the here and now. But building a strong foundation for a growing business also requires strategic tax planning for the future sale of a business.
That’s where the guidance of a qualified, proactive tax partner comes in. Pre-transaction tax planning is an essential part of general business planning and should be integrated with personal financial planning, estate and trust planning and charitable planning. It is common for an entrepreneur’s business to be their most valuable asset, and early, integrated planning is essential.
Pre-transaction Checklist for Entrepreneurs:
This three-pronged approach ensures that entrepreneurs are prepared for the present, and for the future.
1. Formation decisions – A business’s legal structure has myriad implications for business planning, management, and exit strategies. The formation decision impacts all aspects of a business including liability exposure, capital structuring, financing opportunities and tax mitigation strategies. All of these elements in turn impact exit options and the related tax impact.
2. Financial planning – Develop a comprehensive financial plan including financial goals, net worth analysis, retirement plan, estate and trust plan, charitable plan and insurance plan. This financial roadmap will be critically important as the roadmap for pre-transaction strategy decisions.
3. Business valuation – A early-stage valuation analysis is essential for both financial planning and estate tax mitigation purposes. For example, it may be possible to populate irrevocable trusts with closely held company stock at a discounted valuation, thereby moving stock appreciation outside of one’s taxable estate.
Consider this example: A software company with a high projected growth rate may consider C corporation status, forgoing the benefits of a passthrough structure in favor of qualifying for the Section 1202 Qualified Small Business Stock (QSBS) exemption. But these decisions can only be made with an understanding of the full picture.
What Does Pre-transaction Planning Look Like for Entrepreneurs?
Pre-transaction planning may include a variety of integrated strategies. Though strategies are dependent on a business and its unique circumstances, these are just some of the key strategies that can be incorporated.
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- Section 1202 Qualified Small Business Stock (QSBS)
Maintaining C corporation status or corporate reorganization (i.e., F Reorganization) to C status to take advantage of QSBS exemption. Consider multiplying exemption with “QSBS stacking”.
Related Article: What is Qualified Small Business Stock (QSBS)? How Entrepreneurs Can Leverage QSBS in Their Tax Planning
- Section 1202 Qualified Small Business Stock (QSBS)
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- Valuation
Using an early-stage independent valuation to populate irrevocable trusts at a discounted valuation allows for future appreciation outside of the estate. Trust structure and situs are important considerations. - Personal Goodwill
The establishment of personal goodwill with proper documentation may allow a seller shareholder to pay tax at preferential long-term capital gains rates at the shareholder level. The seller should insist on a separate transaction document for the sale of personal goodwill. This strategy may also allow the entrepreneur to mitigate exposure to Net Investment Income Tax (NIIT). - 83 (b) Election
Making an 83 (b) election to treat business interest as a capital asset can be used to take advantage of preferential capital gains rates. - State Relocation Analysis
Considering the tax advantages and timing of relocating to a low-tax state. - Puerto Rico Act 60
Entrepreneurs may consider establishing residency in Puerto Rico (while maintaining United States citizenship) to take advantage of significant tax benefits. - Philanthropic Planning
Consists of a donation of stock to a charity or charitable trust (private foundation, donor-advised fund, charitable remainder trusts, etc.) The taxpayer receives a charitable deduction at fair market value subject to adjusted gross income (AGI) limits in addition to other estate planning benefits.
- Valuation
Proactive Planning Directly Correlates to Success for Entrepreneurs
Delaying pre-transaction planning or failing to plan at all can lead to a myriad of complications, and the costs can be substantial. Many of the above referenced tax mitigation strategies must be executed early in an entity’s life cycle, or the opportunities will be lost.
Our well-established and synchronized process leverages the professional acumen and experience of our Certified Financial Planners (CFP), Certified Public Accountants (CPA) and estate and trust attorneys. The above referenced strategies are only some of the methods we have incorporated for our clients. We welcome the opportunity to understand your unique situation and help you develop and manage a thoughtful and comprehensive exit plan.
A Shared Mindset for Growth – Get in Touch with Us
With a proactive tax partner by your side, you can feel confident that your business, your most valuable asset, will be well-planned and protected.
For more information on how our entrepreneurial tax advisors can contribute to your success ahead of a sale, merger or acquisition, contact us here or call us at 561.453.1441.
LEGAL OR TAX: The information herein is not legal, such as trust or estate planning, advice, or tax advice. Any such information is provided for illustrative purposes only and must not be relied upon without the benefit of the advice of your lawyer and/or tax professional. Lido specifically disclaims any liability from any reliance on such information. Lido is not a legal service provider or tax professional and does not offer legal or tax advice. Should you desire to obtain tax or legal services or advice, you must enter into your own, independent engagement agreement with a licensed attorney or tax professional.