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Heidi
Bolger

A tax-efficient way to transition business ownership to the next generation

Why your clients should opt for grantor trusts.

October 18, 2012

by Heidi Bolger, CPA/ABV

As CPA advisers, we are often sought after for sage advice on tax matters. So it should come as no surprise that our clients will turn to us for creative and tax-efficient solutions when they take the big step of turning over ownership of their business to the next generation.

Finding the optimal ownership transition plan for closely held businesses always seems to boil down to finding a way to meet the exiting owners’ need for future cash flow while balancing the businesses’ ongoing cash flow needs, so as not to kill the golden goose.

Here’s an example of how not to do it.

In the ownership transition of a small family funeral home, the father required his two sons to pay for the business over 20 years, ultimately forcing one of the sons to exit the business because there simply was not enough money to go around.

That situation piqued my interest in finding a better way. Although we cannot control greed in an existing owner/parent, we can look for the most tax-efficient ways to achieve client goals and coach them on structuring sustainable transactions.

One of the options worth considering is an installment sale of the client’s business interest to a grantor trust. Assuming the transaction is properly structured, this method can result in the transfer of a business interest to the next generation with no gain recognized on the sale. See the exhibit below on how to structure this type of a transaction.

Exhibit: Installment sale to grantor trust

As the exhibit shows, the cash flow to fund the installment sale payments has to come from profits of the business. The reality is that the business cash flow has to “fund” any sale of the business. The primary benefit of this structure is that the transfer of ownership occurs with no taxable gain on the sale. Having the trust income taxed to the exiting owner essentially creates a nontaxable gift to the next generation beneficiaries while reducing the grantor’s gross estate by virtue of paying the taxes at the same time.

The trust essentially freezes the value of the business at the time of the purchase, which helps with situations in which the value of the business is rapidly appreciating. Additional benefits are realized through the control retained by the owner while the installment sale process is under way and the exclusion of the value of the business interest from the owner’s gross estate value.

Using an IDGT seems to work best with large estates where business assets are growing rapidly in value, though like most tools, it’s not for every situation.  

As CPA advisers, providing creative ways to help clients achieve their business transition goals keeps us in the “high-value-added, trusted adviser” category.


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Heidi Bolger, CPA/ABV, CFFA, CMAP, is a founding principal of Rehmann Consulting and advises clients in the areas of succession planning and business sales.

* The AICPA’s PFP Section provides information, tools, advocacy, and guidance to CPAs who specialize in providing tax, retirement, estate, risk management, and investment advice to individuals and their closely held entities. All members of the AICPA are eligible to join the PFP Section. CPAs who want to demonstrate their expertise in this subject matter can apply to become a PFS credential holder. For more information on the IDGT technique, visit the AICPA’s PFP Section. Forefield Advisor, which offers clear explanations for your clients, and Bob Keebler’s “Mathematics of Estate Planning” archived web seminar are examples of resources available to PFP/PFS members.