22 July 2024: Selling Your Business: U.S. Supreme Court Weighs In
“Small business owners have lots of aggravations. The U.S. Supreme Court just added to their burden.”
So begins an article by Laura Saunders, tax columnist for The Wall Street Journal. A rather inauspicious opening to an article that describes a potential major problem for business owners using a oft-utilized strategy to protect their business in the event one of the co-owners of their business dies.
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When selling your business, one of the most important aspects to consider is, of course, estimating what you’re likely to walk away with. Aside from the customary costs of sales – legal fees, brokerage commission, document prep, virtual data room, accountant fees, financial planning costs, etc. – taxes must be considered. And because taxes are, in almost all cases, the most significant chunk of your proceeds that are vaporized, there has been over the years no small army of schmaat cookies devising ways to mitigate that damage.
For at least the past four or five years, we’ve written about a favorite strategy – the deferred sale trust (DST) – for reducing the tax impact when selling your business. Using a DST could, for many sellers, eliminate the immediate tax hit, allow any applicable tax to be paid over many years and provide the seller with the opportunity to invest the full extent of the proceeds, giving those proceeds the opportunity to grow.
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This is significant insofar as investing as the returns generated by, $2.5 million of net proceeds before taxes will be significantly greater than those generated by an after-tax net of $1.6 million.
The Companion Issue
The interesting aspect of the case in question is that it was impacted by “a common succession strategy for many closely-held firms with more than one owner.” Specifically, the need for life insurance to be in place on all owners, a topic we’ve written about on multiple occasions over the years..
In the event described it the article, two brothers owned a building supply business that they never had valued but, after one of the brothers died, was valued variously at $3 million by the family (still no professional valuation was done) and $3.86 million by the Internal Revenue Service, the tax authority in the United States.
The two brothers had planned for the potential that one of them might die before they retired or sold their company by having their company buy life insurance policies on each of them thus enabling the company to buy back the deceased owner’s equity from that owner’s estate.
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Many of you have asked if our Flagship Course, “Learn How to Value and SUCCESSFULLY Sell Businesses“, could be made available on a module-by-module basis. Instead of enrolling in the complete course, could you enroll only in the module(s) you wanted? We’re happy to report that this is now possible.
We’ve broken our Flagship into six separate modules (or module groups) to give you all the flexibility you need to learn only what you want to learn – and we’ve moved them all over to the new Brokers Academy in The Brokers Roundtable℠ . The Flagship is still available but the modules are now available individually.
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Their strategy is one commonly used by many owners with good advisors. Unfortunately, though the IRS lost in the lower courts, it appealed to the U.S. Supreme Court and won.
The case hinged upon the treatment of the life insurance proceeds and how they were reflected in the business’ valuation. The decision was unanimous and resulted in an increase of the tax owed by the deceased brother’s estate of nearly $900,000!
When considering selling your business, this case underscores the need for three owner considerations:
- The importance of periodic valuations: You’ve got to have some idea – a realistic one – of your business’ worth. Without that knowledge, it’s impossible to properly plan for catastrophic events.
- The importance of proper insurance: Whether you’re the sole owner of a business or you have one or more co-owners, your death or that of another owner will, even aside from the emotional loss, almost certainly be one of those catastrophic events; one that could conceivably wipe out the business.
- The importance of proper documentation: If you’re a business owner, is there a document describing what you want to happen in the event of your death? What happens to your employees? Who can sign checks? Who can contractually bind the company? How is your family impacted financially?
The article gives the details of the case in question and explains the reasoning of the court. It will be compelling reading for anyone who owns a business and should be at or near the top of your “gotta read” list. Being unprepared for this potential event is nearly guaranteed to cause untold grief to your co-owners and family. But being forewarned is being for-armed.
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Our course, “Learn How to Value and SUCCESSFULLY Sell Businesses“, teaches you how to accurately value and successfully sell businesses.
The Bottom Line
Business brokers – including your humble correspondent – are rarely tax experts. But our sense of this ruling suggests that though the outcome of this case should have little impact on the DST strategy of deferring taxes, it may have significant impact on succession planning done by the owners of small businesses.
And this is an important component of a business broker’s need to manage the client’s expectations. We don’t need to – if fact, can’t – advise our clients on tax or legal issues but it is incumbent upon us to make them aware that there are such tax and legal issues; to make them aware of what we know might impact them; and advise them to seek clarification from someone with the expertise to guide them.
Whether you’re a business owner considering selling your business or a broker advising such owners, I encourage you to read the article and speak with your accountant or tax advisor for more information and further clarification.
I’d like to hear from you. What topics would you like me to cover? How can we tailor these posts to be more useful to you and your business. Let me know in the comments box, below, or email me at jo*@Wo*******************.com.
If you have any questions or comments on this topic – or any topic related to business – I’d like to hear from you. Put them in the comments box below. Start the conversation and I’ll get back to you with answers or my own comments. If I get enough on one topic, I’ll address them in a future post or podcast.
I’ll be back with you again next Monday. In the meantime, I hope you have a safe and profitable week.
Joe
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The author is the founder, in 2001, of Worldwide Business Brokers and holds a certification from the International Business Brokers Association (IBBA) as a Certified Business Intermediary (CBI) of which there are fewer than 600 in the world. He can be reached at jo*@Wo*******************.com