Learn How We Helped a Family-Owned Business Save Taxes and Reduce Complexities

March 27, 2023 by Interchange Capital Partners

How we helped a family owned business

By Brian Baum, CEPA®, CFP®

Running a family-owned business is an incredibly difficult task. You have to create and grow a valuable service, manage employees, deal with inherent family dynamics, and work with a team to do all the legal, compliance, and behind-the-scenes tasks associated with being a business owner. After all that effort and work, you naturally want to keep as much of your hard-earned money for yourself as possible.

Yet with our complicated tax code and legal structures, that isn’t an easy assignment. Building and managing a professional team of advisers to help reduce the complexities around tax, legal, and banking is a key reason why many family-owned businesses seek out our services

Five years ago, a family-owned business approached us seeking help to build and professionalize their family office, prepare for a potential sale, minimize their tax liabilities, and reduce the inefficiencies around their legal structures. While they started out with a complicated structure and a lack of understanding of all the moving pieces, the family desired a group to help them navigate and resolve the complexities of this type of transaction. 

In this case study, we’ll explore how we helped them through our collaborative and comprehensive approach with appropriate tax and legal advisors saving them $44M in taxes while reducing their legal and banking complexities. Some of these results were immediate while others took place over a three-year period.

Donor-Advised Funds (DAF)

The first strategy we utilized was a donor-advised fund (DAF). Since the business was a C corporation, moving stock into the DAF was a viable option and produced some pretty significant benefits. It should be noted, though, that if the business had been an S corporation, this strategy may not have been as effective.

We put $3 million of company stock into the DAF before the sale, reducing a portion of what they owed on taxes. They were also able to claim a $2.99 million tax deduction, which resulted in a total federal tax savings of $1.797 million. In the end, that meant that $3 million was never taxed, they received an additional tax deduction, and they were able to seed their philanthropic goals.

Qualified Small Business Stock (QSBS)

Next, we took advantage of qualified small business stock (QSBS). Again, since the company was a C corporation, we were able to use this feature. If you qualify for the QSBS capital gain exclusion, your business can eliminate the first $10 million of capital gains or 10 times your basis, whichever is greater.

Yet that’s not all. This advantage actually follows the taxpayer, which means that each of the family members who owned the company were able to eliminate $10 million of capital gains. However, because of the way the owners acquired their portion of the company, instead of being able to eliminate well over $100 million total, it actually had to be reduced by 50%. That still meant, in total, we were able to reduce their taxable income by over $60 million. Whether you are able to claim 100% of QSBS or 50% will depend on a variety of factors, which is why it’s important to have the right tax and legal representation that collaborate well helping you along the way. By utilizing this and understanding the proper mechanics, they eliminated $16.6 million in taxes.

State Income Tax Savings

The family we worked with was living in one of the 42 states in the U.S. that has a state income tax. After the sale of their company, they were planning to move to a state without a state income tax. Instead of waiting to move until after the sale, we encouraged them to move well in advance of the sale so they could take advantage of the lack of state income taxes. Simply by moving a year and a half before the sale, they were able to eliminate $2.8 million in taxes.

Tax Payment Strategy

Our tax payment strategy allows your family office to become its own bank. In practice for this family, we created a line of credit allowing them to access $23 million. We used this line to pay their federal tax bill instead of using the cash they received from the sale. With the extra cash still in their control, we invested it and grew their money by $10.2 million. At the same time, the credit line had a low interest rate of LIBOR plus 50 basis points, which resulted in only paying $325,000 in interest. As a result, not only were we able to grow their investments, we also saved $97,000 in federal taxes by deducting the interest expense they paid since 2019.

Gifting Family Limited Partnership (FLP) Units to Spousal Lifetime Access Trust (SLAT)

Finally, we utilized a strategy that involved gifting family limited partnership units to spouses, using spousal lifetime access trusts. Again, there are important technical details in this type of transaction, and different factors you need to evaluate to know if it makes sense for your situation or not. But for this large family, moving the limited partnership units to different spouses allowed us to lower the total value of their estate from $106 million to just over $76.5 million when taking into account discounts for lack of marketability and control. It also allowed the family to claim an additional $15.2 million in gift tax return, which helped from an estate planning perspective. We should also note that we didn’t lose any access to the money in this process due to how the trusts were designed, which is another benefit for the family.

How Can Your Family-Owned Business Save on Taxes and Reduce Complexities?

While the tax mitigation and legal strategies in this case study were the right choice for this particular business family, the right options for your family-owned business might differ. Regardless of the tax mitigation and legal strategies you use, it’s essential to have a team of specialists and a group who can bridge the gap between the various experts needed and the family to create clarity, understanding, and an action plan.

If you are looking for this kind of partnership, as experts in family business, we would welcome the opportunity to see if we can help. You can email me at brian.baum@interchangecp.com or call our office at 412-307-4230 to schedule an introductory appointment.

About Brian

Brian Baum is the managing director of Interchange Capital Partners, an independent registered investment advisory firm providing family office and transition strategy services to family businesses. With over 10 years of experience, Brian spends his days working with our clients to determine ideal strategies to simplify and optimize their processes and the future of their business. He is known for his attention to detail and going the extra mile to become familiar with the dynamics surrounding each situation so he can offer customized and creative guidance. 

Brian has a bachelor’s degree in psychology with a minor in business from Penn State and is a  Certified Exit Planning Advisor (CEPA) and CERTIFIED FINANCIAL PLANNER™ professional. Brian is also the president of the Pittsburgh Exit Planning Chapter, which he helped found in 2019. The chapter’s mission is to give business owners a forum to become educated on how to build a valuable and transferable business through a proven process. Outside of work, Brian enjoys spending time with his wife, Natalie, and their daughters, Quinn and Blair. He is also an avid golfer and likes the occasional scotch and cigar. To learn more about Brian, connect with him on LinkedIn.

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