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Issue 42 – July, 2023

Business Owner Transition and Charitable Planning

By Thomas Griffith, AEP®, CAP®, ChFC®

For many business owners, a business sale is more than a transaction; it’s a major life transition. Their business is often the largest asset that they own, as well as the key part of their financial and estate plans. What’s more – their business has likely played an important role in shaping their daily life and identity. A failure to fully align the sale of a company with their personal plans could potentially undermine the long-term wealth preservation and family engagement opportunities afforded by the business deal. This is especially true for owners with charitable components to their plans.

At a recent forum I attended on the subject of business ownership, the main themes were collaboration and transitions. Preparing for a business sale involves assembling a team of advisors, reviewing financial and estate plans, assessing the transition and creating a plan of action. This work really needs to begin early in the business formation, because you never know when a transition will occur. Whether it is unexpected happenings like the “5 Ds” (death, disability, disaster, divorce and disagreements) or the planned changes such as retirement and incorporating the next generation into a family business, the earlier the planning begins with a collaborative team that works with the business owner’s values as their guide, the better chance of success.

The forum also highlighted the advantages of having advisors with people-focused skills and how retaining an advisor with that specialty can be of value. That may mean a psychologist to help coach the business owner on how to have difficult conversations with key employees or a life coach to help plan a purposeful transition into retirement; both areas play a big role in overall success of a business transition if planned and executed well.

Without a plan in retirement, the stress of feeling bored, aimless or isolated can even significantly impact your health. Having a new purpose and goals can help. One new donor that began working with me when their business sold last year told me that he missed the network of downtown business owners. No longer part of that “club”, he is looking forward to engaging with people and organizations that care about neighborhood revitalization especially for the one where he was raised.

Also, by incorporating effective charitable discernment and planning, business owners can reduce estate tax, avoid capital gains tax, create a charitable income tax deduction, reduce tax to heirs and generate charitable resources to help the now former business owner and their family achieve their desired impact.

How Does It Work?

In the simplest case, a cash gift to charity can be made either before or after the sale of the business. As long as this is done in the same year as the sale, a tax deduction will help offset the income received. The needed tax deduction is often much greater than the client’s annual charitable giving. Using a donor-advised fund, the gift can be made in the year needed for tax deduction purposes and grants may be distributed from the fund to support charities of the client’s choice for many years into the future.

The cash gift, while simple, does not maximize the tax advantages of gifting. A preferred approach would be to gift stock or ownership shares to a donor-advised fund prior to the business sale. When the sale occurs, the fund receives the proceeds from the sale for its portion. This creates a charitable deduction similar to gifting cash, and also avoids taxation on any capital gains embedded in the ownership because the fund is administered by a tax-exempt public charity.

This same concept extends to real estate as well. Two recent gifts that I worked on in this area are a ski condo that was less frequently used by the donor as they got older and an apartment complex that the owner wanted to move on from in retirement. In each case, there was a large amount of capital gain embedded and by gifting either the entire piece of real estate or just a portion prior to sale, all or some of that capital gain was avoided. And like the business sale example above, the owner/donor also receives a charitable deduction for the value of the gifted real estate.

Using a donor-advised fund especially at a local entity such as a community foundation also provides ongoing charitable planning support. Whether it is legacy planning or engaging future generations in giving, there are often extensive resources to deploy. For example, at my community foundation, we have a flexible discernment process that allows donors to work at their own pace with a range of tools to develop their legacy plan. Staff members are available to facilitate family meetings and to help donors maximize use of their fund as their needs change over time.

There are also more complex planning tools that can be incorporated into a business sale. For example, charitable remainder trusts can be used to create income streams for heirs while ultimately creating a charitable resource. This type of trust planning can be useful for wealth distribution and addressing spendthrift or creditor concerns with heirs, since only an annual percentage of the trust is accessible by the beneficiary.

Another tool is the charitable lead trust, which creates an initial charitable resource by paying out a percentage of the trust for a number of years to a charity. This charitable distribution up front allows for tax-efficient transfer of the trust corpus to heirs in the future. In both the charitable remainder and charitable lead trusts, the asset is gifted to the trust and the trustee manages it until trust termination. The trustee fees and costs of tax returns each year for the trust do add to the cost, so these gift options may be less attractive for smaller gifts.

Throughout this piece, there are references to advisors. Selecting advisors that can work collaboratively to advance the discernment and planning needed for charitable clients is key. A couple of designations to look for when selecting charitable advisors are the Chartered Advisor in Philanthropy® and the Accredited Estate Planner®. Both of these designations demonstrate a commitment to collaborative, holistic planning.

Regardless of your charitable client’s needs, proper planning can result in a more tax-efficient and comprehensive result for their financial and estate plans as well as the inclusion of a steward to their charitable plan. When we work together, everyone benefits. When our community thrives, we all thrive. As a final thought, I hope this article encourages you to connect your charitable clients with your local community foundation.