The last few reports have dealt with the financing of your Buy-Sell Agreements, the heart of your Business Succession planning. We last discussed the use of a Private Annuity which is the sale of a business by the parent to usually the children who will eventually take over the business. Let’s review some unique tax consequences of this approach.
A private annuity can not be secured by a note or collateral. In other words, you can not take the property back if your buyer decides to stop paying. Each payment is part principal and interest and is established by using rates from life expectancy tables. So in some instances it makes sense to use a private annuity when the owner is in poor health. The result is that the buyer, usually a family member, could end up paying very little for the business. The private annuity stops when the owner dies.
From an estate planning perspective, this method helps reduce your estate (federal and New York State) tax liability. This is because when you accept annuity payments, the current value of your business is removed from your estate. Additionally, the seller may be able to spread capital gains over the lifetime of the private annuity. Also keep in mind that the buyer’s payments are not tax deductible. Lastly, be aware that a GIFT TAX could occur. If the amount of your annuity payment is LESS than the amount prescribed in the life expectancy tables, the IRS could always claim that the buyer paid less than the Fair Market Value. Thus, the difference between the real value and the value of the payments could be viewed as a GIFT and result in additional gift taxes.
The private annuity may work for you so please consult your team of advisors and compare this to the other methods we have discussed.