There’s No Perfect Plan: Wealth Transition Concerns When Exit Planning

HOST Clinton Laron

GUEST Ava Archibald Principal-in-Charge | Wealth Transition Services Eide Bailly

The Transcript

Clinton Larson: Hello and welcome to EB & Flow. I'm your host, Clinton Larson. And today's topic is going to be about wealth transition concerns when you're exiting your business. And joining me to talk about that topic is Ava Archibald, principal in charge of Wealth Transition Services at Eide Bailly. Welcome to the podcast Ava.

Ava Archibald: Thank you Clinton. 

Clinton Larson: So our last episode, we talked a lot about some of the key considerations when people are selling or transitioning their business. And today, we're going to take a deeper dive into one of those areas that you definitely don't want to overlook. And that's how you handle the financial concerns in that sale. I'm curious, how often do people have an idea of that side of the sale ever once that, you know, they have the cash in hand, so to speak?

Ava Archibald: I don't think that people often look at that holistic approach that they should probably consider when they're selling their business. You know, oftentimes when someone's selling their business, they're thinking about what is going to be that that cash sale amount. But really, you have to think about what's the net tax effect, what's going to be the cash in my pocket at the end of the day after I pay the tax?

You know, if I'm selling of a corporation, let's say it could make a big difference if I'm doing an asset sale or a stock sale. And you might want to run those calculations to really know what that end tax net tax amount would be, that net cash amount in my pocket, because that's what's going to affect your family and that's what's going to affect you for your cash flow going forward.

Ideally, if someone's going to look at either transitioning down to the next generation for family businesses or maybe doing a third party transaction, if we could visit with that client one or two years prior to the sale, that's ideal. That gives us some time to look at, you know, what is their family goal? Do they have family members that are stepping in to the family operations? Are they really looking at doing an outside sale? And if you're doing an outside sale, are there things we could do prior to that sale to put them in a better position from an estate tax perspective? Because once we've sold the business and we have cash in our pocket, that's what we have. But if we could do some of that transitioning ahead of time, we can really save family some money.

Clinton Larson: Great. And so let's talk maybe about like that ideal situation, right? If you say, you know, a person has a year or two ahead of time, they know they're transitioning in the business and they have a little bit of runway ahead of them. What are some of the things that you go through with clients and people who are in that stage to get them ready to do what you're saying to make sure that, you know, when the sale is over there, they are set up to reach the goals that they have for themselves and their family.

Ava Archibald: Well, the first thing we do is sometimes people are so focused on the business and a lot of our closely held business owners, that's where they've put all their wealth into that business. But we want to look at the whole picture. What are all your assets? Because if you were taking a salary from that business or you had distributions from the company coming out every year, and now we sell the business, we want to make sure that you still have a cash flow after the business transitions or is sold. And is that cash flow going to carry you through to your future years?

We also look at what is your overall net worth? And, you know, my world is looking at the transition tax. So that's that gift and estate tax. And if you are over the estate tax threshold, which today is 12 million per person, just over 12 million, but in 2026, that amount is slated to change to about 6 to 6 and a half million based on the current law. Under the current law, there's a sunset provision that the estate tax exemption is going to drop to be a significantly lower amount in 2026. So husband and wife could have about $13 million together. Anything over that that you gift or die with is taxed at 40%. That's a large tax rate that ends up to be a big tax bill to pay.

So if you're selling a business, let's think about is there a way we could maybe transition some of these business interests, especially if you're going to sell it for a highly appreciated value, transfer down to your family members now at a lower value, if we're transferring something that's less than a controlling interest, there's opportunities to transfer it with discounts, lack of marketability, lack of control discounts, which really many times can reduce that business value for gift and estate tax purposes by 30 35%, where if I sold it at 100%, I have 100% value in my pocket that is going to be subject to estate tax when I die or a gift to my kids.

But if I transferred it now, maybe ahead of time, we can do that at a compressed value. That way, when you sell it for this appreciated value down the road, that appreciation is out of your estate tax free at 40% tax rate. That's a big savings. But with that, we always have to think about, you know, we can write the best tax plan to save your end of life taxes, your estate and gift tax. But if you don't walk out the door after we do that planning, feeling like you can continue your custom manner of living, you still have the same cash flow. We didn't do any successful planning for you.

So that's where we're taking a look at if you're going to get out of the business, what's the cash flow or the salary you're taking now? How are you going to make up for that cash flow later? And what is your total net worth and what's your estate tax going to be down the road for your family? Is there a way we can shift that value now to your kids still keeping the cash flow for you? So a lot of moving parts, but if it's done right, we can save the family as a whole significant amount of dollars in taxes.

Clinton Larson: Yeah, that does sound like a lot of moving parts. I mean, I was thinking about all this stuff you were just talking about earlier in terms of, you know, how you want to transition your business. What kind of effect do you want that to have on your current situation, but also your situation, you know, 20, maybe 30 years from now? And then considering also, you know, what kind of estate you're going to leave your family, you know, in in that time as well. So, I mean, it does sound like there's a lot of complexity here. So let's start with some of the those details you were just mentioning, you know, in terms of if you want to try to transition some of your wealth now ahead of a sale, what are some tips you'd have for people to start to lay the groundwork for that?

Ava Archibald: Well, first, we're going to look at the operating agreements for the business and make sure that we can obtain the most discounts for gift and estate tax purposes because what establishes those discounts for gift and estate tax purposes is really the restrictions or what is within your, let's say, your operating agreements of the business. So we take a look at that. And if that is structured appropriately, then there's techniques we can use where we can sell the business interests, let's say, to a trust and take back a promissory note.

And if the trust is structured in the appropriate manner, we can avoid any transition taxes in that regard from an income tax perspective, there would be no capital gains on that transaction because the trust is going to be written where I'm still the responsible party for income tax purposes. It can be a significant way to save taxes on transitioning assets to the next generation. Because if I sold, say, my stock to a trust at a discounted value for gift in estate tax purposes, and then down the road some time my trust sells that stock and the appreciated value all that appreciations out of my estate tax free because I sold it earlier on at this discounted value. That's why we want some time in between. Two years is great, a year's good, six months is still doable. Once you have a letter of intent on a sale or purchase agreement. Now it gets tough to do that type of planning.

Clinton Larson: That's great advice. And I was thinking too about, you know, in terms of the cash flow stuff you were talking about as well, how much do people have an idea of that when you know, because I imagine a lot of business owners are there in their business. You know, that's the life they're focused on, you know, when it comes to that idea of the next step and when you're not, you're no longer running your business and you need to make sure you have the cash flow that you need to have to live the life that you want to live. How many people have an idea of what that is or how many people are surprised by what they might need or what they might need to do to achieve that?

Ava Archibald: You know, we all think about it. We all think about what we spend on an annual basis, on our custom manner of living. And everybody has a different manner of living. But if you talk to a married couple, even husband and wife many times have a different expectation of what do they need going forward to live on? What works best, I think with our clients is we have a Wealth One product through Eide Bailly Financial Services that I will partner up with when I'm doing this transition planning so that they can see it in up on the screen of here's my value today and my cash flow if this is what we say we spend on an annual basis and we want to project that out ten years down the road, our Eide Bailly Financial Services has a program that they can illustrate that for our clients so they can see it in real time.

What does this look like on a certain return ten years down the road, what does it look like 20 years down the road? You know, maybe. I think I need 5 million and that's going to take me out through retirement. But once you start thinking about what I want to do in my next 20 years, maybe that isn't enough. Or maybe I don't spend much and maybe that 5 million is going to turn out to be 25 million down the road by the time I pass. It's great to see it and to visualize it on a program such as our Wealth One program.

I worked with a client once and he was selling his business and he had a set in his mind that all he needed was 7 million, everything else he gave to trusts for his children. And we talked about it multiple times. I wanted him to look at our illustration just so he could visualize it, and he'd be comfortable. But he was set in his mind until the day before the sale. Now he did the gift to the children's trust. He was going to have net after tax, $7 million in his pocket. And he got really nervous that this is not enough money. Why did I only keep 7 million?

You know, seeing it up on the screen and looking on that growth of the 7 million. He would have been much more comfortable seeing that. But it's hard to conceptualize so putting the numbers to a page or to an illustration, whether a flowchart or know, I don't know. Like our Wealth One product, it just lets people see it instead of just conceptualizing it.

Clinton Larson: That's an interesting point there, because I feel like a lot of people, like you said, it would have maybe they have an idea of what their retirement's going to look like, maybe they have some goals in mind. But once it's actually real, I feel like it's probably a whole different feel for people. So I'm curious, like when you're talking to people in this transition phase, you know, they're about to move in the direction of a pretty, you know, life changing event. So how do you how do you talk to people about those goals that they have for retirement? How do you work through that with people? Because, you know, I imagine, like I said, some people probably have a very clear idea in their head and maybe that changes in a day. Or maybe some people just have no idea and they're just like, I don't know what I'm going to need. So how do you work through that with people when you're trying to determine, you know, something so specific as a number and then related to something so complex and idiosyncratic as your retirement goals?

Ava Archibald: I try to back away the numbers in the initial conversation. I first want to hear what their goals are for themselves as a as usually a married couple. What are you looking for down the road? Ideally, what do you want to have happen for your family going forward? Especially if we took tax off the table? Once I hear a little bit more about them and their family, their family dynamics, then we can back into the amounts they need and the amounts that make them comfortable and let them achieve what it is that they want for their family going forward.

Some people may have a set dollar amount that this is all I want my children to have. The rest is going to charity or this is the amount I want to make sure that gives me comfort. You know, might be very different to the couple next door, but everybody has their own comfort level of what they believe they want. So once they know that and what they want for the family, then we can work it out and get into the details and really work into key. So what does that look like?

And now what is it really that you do need annually and what do we need 20 years down the road? Are you looking at buying that second home? I notice sometimes husband and wife, when we start having these discussions, there's a big difference of what the wife may want for the family versus what the husband wants for the family. It's great to start talking about those things because it's hard to have that discussion sometimes. But once we can get their goals in line, we can back in to their cash flow and how the tax will play out and help them achieve what that goal is.

Clinton Larson: That makes sense. And as you're talking to I'm thinking to as well that like this obviously isn't a static plan, right? You know, like if you have a plan for your retirement, you know, year one, year two, by the time you get to year three, maybe you might have a whole different idea of what you want to accomplish or do. I'm curious, how do you work through the changes that are probably inevitable in any sort of wealth plan that someone might have?

Ava Archibald: Well, I let people know once we have a plan in place that isn't the end of the line. I mean, if there's a change in legislation, we most definitely want to be reaching out to our clients. Like I mentioned earlier, the estate tax exemption is the largest it's ever been that I would call it 12 million, just over 12 million per person. But it's going to drop in 2026 to about six, six and a half million per person. That's a really big change that's going to change someone's maybe game plan. So maybe we have them set today at a very comfortable place from an estate tax perspective. But come 2024 or 2025, we may need to revisit with them if this law looks like it's going to stay in place.

There's a lot of people who might be doing or changing their estate plans to account for that. When we're drafting plans today or working with clients on drafting a plan and doing that kind of tax projection. We're already looking at what is your tax look like today if you pass or gift, what does it look like in 2026 if this does drop? The other thing to think about is personal lives change. You know, maybe one of their children will have some difficult health event or something or one spouse may pass. That changes things. And we want to revisit with those clients when those things happen. The benefit we have in doing estate planning in an accounting firm is we connect with our clients once a year when we're doing their tax returns. That's an ideal time for us to have those conversations and find out if there is that life changing event where maybe we need to change the plan up a little bit.

Clinton Larson: That's a good perspective because I was just thinking that this is also something where there's certain aspects of a sale that you're going to deal with somebody. And then once the sale is through, you know, then, you know, it's a handshake and a goodbye. But I'm guessing with a lot of the clients you work with, you're probably working with them for quite a few years, correct?

Ava Archibald: Many times, because after they have that sale, life has changed and their financial situation has changed. Sometimes it education. If it's an estate plan that we've put in place, like the one I described where we may do a sale to a trust. There's a lot of things we want to make sure that happen correctly because you can draft the best plan. But if it's not followed through with you don't implement the plan down the road and take the right steps after the fact. All that planning you did on the front end could be for nothing. And maybe all that estate planning I did is going to come back. You have to make sure you take the right steps.

So I always say the key to a successful estate plan is the implementation, making sure people follow through. If you're creating a trust, operate that trust in the right manner is no different than if you create a business. We have to operate the business under the business operating agreements. You have to do the same thing. If you're doing any planning with the trust or making any gifting, make sure you really made the gift. Implementation is key and that's communication with their clients after the plan is set in place.

Clinton Larson: So for people who are looking for an advisor for this this type of event in their life, you know what you're just talking through? Obviously, you want to if you're going to be working with someone for potentially years, if you're going to be re revisiting the plan and creating new goals and new ways to reach those goals, what should people look for in an advisor when it comes to this kind of this wealth transition topic that we're discussing?

Ava Archibald: I think you want a firm that is going to have succession. So in a firm such as Eide Bailly, you know, I may be retired sometime down the road, but there's a whole team behind me that can pick that up and work with not only the business owners, but their family, their children going forward. Because once you know, all that history, we just can do such a much. We can do a much better long-term plan for a family when we know there's going to be people behind us carrying on with their successors as well.

The other thing to think about is you want to look at someone who can look at that holistic picture. And that's, I think, the benefit of working with Eide Bailly in that we have, you know, not only if you're working with me and I'm thinking about transition taxes I can bring in our Eide Bailly Financial Services who can look at that cash flow. Maybe we're bringing in the business valuation team to see what kind of discounts we can have. And in some of this gifting, as you set up these trusts in your multiple accounts, maybe you're looking at our BOS services and helping you do some of that work in the future. It's nice to have the resources to bring it all together for high net worth clients.

Clinton Larson: So ideally, if you have given yourself enough time to to think about the questions we've been talking about, to create that plan for the sale of your business and also for, you know, an effective wealth transition plan. Hopefully, you've been very successful in the you know, in in the financial side of that. And I'm curious when it comes down to sort of that sort of that final question that a lot of people, I think have a hard time asking. But, you know, when it comes to transitioning that wealth into the next generation, you know, what legacy do you kind of, you know, pass down? What are some of the things that people should be thinking about when it comes to that, that sort of final phase of this plan?

Ava Archibald: I think you need to think about What do I want for my family, and that is different for every family. You know, some families, you know, it's an amazing number of people that I work with when they are successful and they've built this wealth, they want to leave it for their family. But one of their main concerns is they don't want their family to lose their incentive to be successful themselves. So part of that is how do we structure this to give our clients the comfort to, again, transition this wealth in a tax efficient manner? But keeping whatever key goals they want for their family members. And we can do that through so many different ways, through different various entities or trusts or structuring a trust in the appropriate manner.

And if you can understand the mechanics of the trust, it can be a means of not saying you keep control. But, you know, if I've created the trust in my lifetime, I've kind of guided what I want to have happen for these assets to my children. You and sometimes it's giving some assets outright to my family. Some of it's protected in a trust. Some of it is even between the husband and wife. If I have a younger couple, we might want to be sure that upon that second marriage, because if one spouse dies early in life, you have to expect the other spouse is going to remarry. How do you protect this wealth we have today for our current children? A lot of that planning is is thinking about that and thinking about the future. There is no perfect family. There's no perfect plan. It's moving parts and making it work for each individual family.

Clinton Larson: Well, that's really good perspective on how much work goes into a plan like this. And going back to the beginning, when you're talking about having that 1 to 2 year sort of timeframe to get started, it sounds like that's really important based on all the complexities involved.

Ava Archibald: It is. The one thing I want to stress for our clients is this is a big step when you're looking at transitioning your business, give yourself enough time so that you can be sure to put that plan in place that accounts for all your family dynamics and gives you that comfort that that you've addressed everything you need to for your family.

Clinton Larson: This has been a really awesome conversation ever, and hopefully we've given people a lot of information to think about because clearly this is a very important issue for any business owner to consider. So thank you very much for being on the podcast. I really appreciate it.

Ava Archibald: You're welcome. Take care.