By Michael E. Wright, CFP®

Successful business owners are decision-makers, but when it comes to protecting their wealth they often procrastinate instead of effectively planning for the future. They realize they have accumulated sizable assets, but they become paralyzed by seemingly contradicting goals: maintaining control of their business assets as they approach retirement, creating income to maintain their lifestyle during retirement, minimizing estate taxes, and providing for their family after they die.

Although it takes extensive planning and implementation, these goals can be accomplished without sacrificing one for the other. There are a variety of ways to maintain control of your business and generate an income stream while making the tax bite less painful during your estate transfer process. You may want to reference some of the following ideas as you look to the future.

Impediments to preparing for a shift in ownership, especially in a multi-generational business, often involve intangible and highly emotional issues. These subjects are frequently avoided and not discussed in many families. A more tangible impediment to be considered is the drain on business cash flow and assets highly confiscatory estate taxes may cause. Estate taxes alone can wreck the existence of the business and future security of your family.

One of the reasons so few family businesses survive into the next generation is because the owners fail to do advance planning and implement a wealth transfer process. When owners die, the remaining family members may be forced to sell the business assets below market value simply to cover the estate tax bill. Estate taxes are due within nine months of death. The top federal estate tax rate is 45%. Estate taxation begins on the first dollar over $2,000,000. The tax law gradually increases the amount at which estate taxes kick in from $2 million in 2007 to $3.5 million in 2009. Business owners should assemble a team of wealth transition professionals who can analyze the estate and suggest ways to preserve the business for following generations while providing income for a comfortable lifestyle.

Gifting stock or units of the business to children is an effective way to transfer ownership and reduce the size of the taxable estate. The savings on estate taxes could be substantial. Gifts of stock directly to your children fall under the $12,000 ($24,000 per couple) annual exclusion rule. For example, a total of $48,000 can be transferred by a couple to their two children without paying federal gift taxes or reducing the lifetime exemption. By owning a closely held business, you may be able to take discounts on the valuation of the business and save on estate taxes when making gifts of minority interest in your company. Because you still maintain control of the business, the discount is a recognition that a minority interest may be worth less because of the lack of control and marketability inherent in minority ownership.

For example, you might give away a small stake in your family business to your children each year and discount the shares by 30%. This means you could give them a stake with a face value of $17,100 per year, discount it 30%, and still remain under the $12,000 annual exclusion limit. Remember, making this gift of stock removes the value of the gift and all its future gains from your estate. Therefore a $12,000 share in the business you give away today that grows at 15% a year for 20 years removes over $200,000 from your taxable estate, a substantial increase that escapes future estate taxes at your death.

Estate tax reduction can also be accomplished with Family Limited Partnerships (FLPs) or Family Limited Liability Corporations. An FLP typically consists of family members, usually parents and their children, or trusts on their behalf. Business shares or units are sold to the trust in exchange for a general partnership interest, and the younger generation is gifted the limited partnership interests. The general partners are liable for the partnership's obligations, while limited partners only have their capital contribution at risk and do not participate in the control or management of the partnership.

FLPs allow business owners to retain control of their assets that are placed in the partnership, yet transfer more than a minority interest by gifting of limited partnership interests. For example, when creating a FLP, you might give away 95% of the business to five family members, while you hold 5% as the general partner. As general partner, you maintain control of your business, while the transfer of the limited partnership interests gets a large portion of your business’ value out of your estate. By transferring limited partnership interests over a period of time, you may utilize your annual gift tax exclusion. The partnership can be structured so that you and your spouse receive income in the form of a salary and tax-deductible employee benefits.

Another reason why so many family business owners delay the transfer of managerial control to the next generation is the fear of losing financial security. In addition to worrying about how their businesses will survive, they also worry about how life will be without their businesses. Owners' children often realize that their parents fail to follow their business advice or invest adequately for the future. The children can often perceive this as a lack of confidence or respect. The principal way to address these issues is with a buy-sell agreement.

A buy-sell agreement is a legal document that outlines how ownership will change hands in case of an owner's death, disability, divorce or retirement. The agreement might provide, for instance, if one of two co-owner siblings retires or dies, the remaining owner has the first right to purchase the remaining shares to keep the business running smoothly. A well drafted, buy-sell agreement should specify the value of the company's stock and a way to pay for the shares.

For example, assume a father (Tom) and his daughter (Sara) owns a business. If Sara wants to buy the family business during her father's lifetime, there are options. If Sara is short of the necessary cash, she might consider a buyout that includes a combination of cash, installment payments and a compensation package in return for her father to be retained as a consultant for a few years during the transition of ownership. If Tom wants to run the company until his death, he should fund the buy-sell agreement with life insurance to provide sufficient liquidity for Sara to purchase the company and provide his wife sufficient income to continue her lifestyle during retirement.

Another kind of estate transfer tool, known as the Grantor Retained Annuity Trust (GRAT), lets you transfer assets from your estate without giving up the income they generate. Using this trust, you can potentially remove an asset from your estate and reduce gift taxes as well as enjoy annuity income from the asset transferred to the trust for a predetermined period of time. The trust beneficiaries eventually receive the gifted assets at the end of the trust term.

Since they are annuities, GRATs pay you a fixed dollar amount each year. For example, the trust could pay you $40,000 annually. One caveat is that if you take more income from the trust than you can use during your lifetime, you will wind up putting that unspent money back into your taxable estate and possibly paying estate taxes on it. The gift tax is based on the present value of the remainder interest going to your heirs. The benefit is you will be transferring the assets at a discounted rate. That means a lower gift tax bill for you. Another possible negative is that GRATs are irrevocable; you can't take the assets back later if you decide you need them. So be sure you can afford to lose control of those assets before placing them in the trust.

Used as a part of a coordinated plan, these ideas may help you meet your goals of maintaining control of your assets, reducing your estate tax bill, creating retirement income, and passing on your business to the next generation.

Michael E. Wright, CFP® is president of Wright Financial Advisors, a registered representative of securities offered through OneAmerica Securities, Inc., a Registered Investment Advisor, Member NASD, SIPC, 9229 Delegates Row, Suite 190, Indianapolis, IN. 46240, 317-573-3838, mwright@wrightfinancialadvisors.com. This information should not be construed as legal or tax advice. You may want to consult a tax advisor regarding this information as it relates to your personal circumstances.