3 Ownership Transition Techniques to Help Family Business Owners Find Opportunity in Today’s Market– March 31, 2020 by Josh Lefcowitz

** This blog was updated on 4/16/20 to reflect May IRS minimum interest rates **

Prior to a few weeks ago, the economy was humming along for most industry sectors; businesses were growing revenue and earnings; and market multiples were strong. Due to the global COVID-19 pandemic, the past few weeks have resulted in extraordinary market volatility, uncertainty regarding the U.S. and global economies, and corresponding financial risk to many business owners. It’s no surprise that enhanced risk, and ultimately decreased cash flows, can drive down the value of your business.

So, where is there opportunity?

Well, if you are a family business owner with sufficient assets, you may want to consider transferring ownership of the business to the next generation. Obviously, every case is different, but if your business has been negatively impacted by the global COVID-19 outbreak, then it is likely that the value is lower today than it was just a few weeks ago. There are three ownership transfer techniques that can capitalize on this lower valuation and ultimately benefit you.

1. Gifting an Ownership Stake in Your Company

A gift of an ownership stake in your company is the simplest approach. This could be accomplished with a direct gift or a gift to an irrevocable trust, which would allow you to have more control over the shares after the gift and provide potential liability/divorce protection for the gift recipient. You must report this type of gift on a 2020 gift tax filing and you would need to have a professional valuation completed for the shares gifted to properly document the value for gift tax purposes. 

2. Selling Shares Via an Installment Note

This is another fairly simple approach that takes advantage not only of the reduced value of your company but also the fact that IRS minimum interest rates have dropped to historically low levels. A sale to your heirs would be structured so that the full purchase price is financed by an installment note payable to you as the seller, with the interest rate set at the IRS minimum rate. The buyers pay back the loan using the future cash flows of the company, which provides you with an income stream during the note term.

The May 2020 IRS minimum interest rates dropped to a historically low rate of only 1.15% for a “long-term” loan, which is defined as a loan longer than nine years. The mid-term rate for loans from three to nine years is even lower at 0.58%. The downside of a sale using an installment note is that it would be a taxable event, triggering taxable income. That said, this would be minimized with a lower valuation and could be spread out over the term of the installment sale to minimize the tax rate you are paying.

3. Gifting Shares to Grantor Retained Annuity Trust (GRAT)

A more complex strategy is to use a Grantor Retained Annuity Trust (GRAT); however, a GRAT takes great advantage of the depressed share price and low interest rates. A GRAT is a trust to which you transfer assets in exchange for an annuity back from the trust. Any assets remaining in the trust after repaying the annuity stay in trust for the benefit of your heirs. The amount of the annuity is typically set up to equal 100% of the value of the assets transferred to the trust, so there is technically no gift made to the trust. The annuity is calculated under an IRS mandated calculation using an interest rate that currently sits at 0.8%, referred to as the “hurdle rate.” The term of the annuity would be at least two years with a payment received at each anniversary date of the establishment of the trust. Conceptually, if the assets in the trust grow in value at a rate greater than the 0.8% hurdle rate, all of that excess growth stays in the trust for your heirs, and for gift tax purposes you have not made a gift. A GRAT can be used with any type of asset, but the one caveat is that if you gift shares of your company, a professional valuation of the business would need to be completed at the funding of the trust and on each anniversary date when an annuity payment is made with shares.

Considering a Defined Value Transfer

Aligned with the techniques above, business owners may contemplate a “defined value” transfer. Proper legal counsel should be involved, but in essence, a defined value transfer is based on the premise that the gift or transfer is limited to a defined value. The number of units transfer at that value is initially based upon an independent valuation, but even if it is challenged by the IRS, the number of units ultimately transferred will be adjusted to match the defined value.

In using this tool, you can make transfers at a date of your choosing and then have the valuation performed subsequent to the transfer, with an effective valuation date that corresponds to the transfer date. All of the associated work must be performed prior to any applicable IRS filing deadlines.

Contact Josh Lefcowitz at jlefcowitz@cohencpa.com for questions on valuations, or Scott Swain at sswain@cohencpa.com for tax issues regarding transfers of ownership.


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Cohen & Company is not rendering legal, accounting or other professional advice. Information contained in this post is considered accurate as of the date of publishing. Any action taken based on information in this blog should be taken only after a detailed review of the specific facts, circumstances and current law.