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Connecticut's Family Businesses

Success and challenges in a tough economy

CBIA News Magazine

May 2014

Bryon Harmon and Lyn Gammill Walker are quoted in an article featured in the May 2014 edition of the CBIA News magazine. An excerpted copy of the article, "Connecticut's Family Businesses: Success and challenges in a tough economy," is featured below. The full text is available here.

Family businesses—companies owned and/or run by two or more members of the same family—are a keystone of our economy, generating a significant share of Connecticut’s wealth and economic output, providing good jobs for people throughout the state, and contributing greatly to local communities and the state’s quality of life.

Putting Off Until Tomorrow  
According to CBIA’s survey, 40% of family businesses in Connecticut lack a succession plan. Although 58% of respondents intend to pass their business on to the next generation, only 7% say they are positioned to do that successfully.

“A lot of family business owners are reluctant to start that process,” says Bob Mulé, chair of the Business Law Department at Reid and Riege P.C. “While typical business owners never want to think about the day they have to retire, it’s more difficult for a family business owner, because he or she is not just thinking about dealing with the business but also about dealing with family members, which opens up a whole Pandora’s box of issues.”

Another reason owners of family firms put off succession planning is that it can be time-consuming.

“It takes a long time to prepare for proper succession in a family business,” says John Turgeon, partner and director of human capital consulting at CohnReznick. “I was speaking with a family business owner just the other day, and it took them somewhere on the order of five years to develop a plan and begin to execute it. Some people think the time horizon is short, but there is so much to do around the emotions and economics of it all to ensure that you transfer the business at the right time at the right value to the right people. It’s just not something you can think up on a Friday and have done on a Monday.”

A key factor that often deters family business owners from starting the succession planning process is the need for an appraisal to determine the value of the company, says Bryon Harmon, partner in the Trusts and Estates Practice Group at Shipman & Goodwin LLP.

“It’s very important that family business owners have an appraisal made of the business,” he says. “That’s got to be the starting point, and it’s expensive, but I don’t think it’s necessarily the cost or complexity [that keeps people from doing it]. Many business owners don’t want an ‘outsider’ coming in and looking under the hood of their business. This is their baby. It’s very private, and they’re worried about competitors, so that often stops succession planning right in its tracks.”

Estate and Gift Taxes
The consequences of failing to develop a formal succession plan can be devastating, for two main reasons. First, family relationships can be irreparably damaged.

“I’ve seen cases where families have been torn apart over issues regarding the succession of their business,” says Chad Stewart, vice president of commercial lending at First Niagara Bank. “So without a clear plan, laid out well in advance, it can cause some significant turmoil.”

The second negative outcome is financial, says Stewart.

“The business is usually the single largest asset the family business owner has. So in that respect, failure to plan can lead to estate tax issues and other issues around the death of the owner. A family may be forced to sell the business if it doesn’t have significant reserves [to pay the taxes on] the transfer.”

Indeed, Connecticut’s gift and estate tax laws can affect a family business “tremendously,” says Cindi Gondek.

“It’s hard for me, because I didn’t realize my kids would come into my business, so it’s changed how I’m going to do things. Even now, I’m not sure how I’m going forward. I have a lot of things in trust and we gift things over to the children to protect the estate. It just brings a whole other set of challenges, because you have to be very careful in Connecticut when it comes to estate planning.”

“Estate and gift taxes are part of the transfer tax scheme,” says Harmon, “the tax on the privilege of passing your assets upon your death [estate tax] or in your life [gift tax]. There is a federal estate and gift tax, and there is a Connecticut estate and gift tax.”

In fact, Connecticut is one of a minority of states that impose their own estate tax and is the only state in the country with a gift tax. Some other states, however, bring gifts made within three years of the death into the estate, says Lyn Walker, partner in the Trusts and Estates Practice Group at Shipman & Goodwin. “So, in effect, they are taxing at least some gifts by way of their estate tax.”

The federal and state estate and gift taxes come with exemptions. On the federal side, the exemption is $5,340,000 for 2014. Anything in excess of that amount is now taxed at a rate of 40%, down from a historic high of 55%. The exemption for Connecticut’s tax is $2 million, with the tax applied to gifts or estates over that amount at graduated rates ranging from 7.2% to 12%, depending on the value of the gift or estate. 

The fact that Connecticut imposes its own gift and estate taxes hurts the state’s competitiveness and its place in national business climate rankings, says CBIA President and CEO John Rathgeber.

“Connecticut is out of step with many other states when it comes to the effect of gift and estate taxes on businesses,” he says. “Here, those taxes, which kick in at a much lower value than those at the federal level, can seriously constrain or even prevent a small or midsize firm from reinvesting in itself, creating new jobs, and developing new products or services—all essential ingredients for economic growth.”

Protecting Your Business
Planning for all the state and federal taxes can be a challenging part of succession planning, says Harmon.

“In a family business, or any business, you may need liquidity to pay the taxes—within nine months of death in the case of the federal estate tax and within six months for the state tax. So, theoretically, if 100% of your net worth [is the business] and you’re above the exemption amounts—which is not uncommon—then you would have to liquidate some or all of your firm to pay the tax. Fortunately, that doesn’t happen with good planning.”

Family business owners can limit their estate and gift tax liability through a number of planning strategies, including making incremental gifts during life.

“In addition to the exemptions, there is something called the annual exclusion against the gift tax, which is $14,000 per donee per year,” says Harmon. Spouses are each entitled to the annual exclusion amount, so together a married couple could give $28,000 to each donee per year without tax liability.

“So if you have a mom and dad and three kids involved in the business, over time you could move out a lot of money. So that’s one device we use to minimize or avoid the estate tax.”

Harmon also points out that the law provides an unlimited marital deduction, which allows someone to transfer an unrestricted amount of assets to his or her spouse without incurring gift or estate tax liability.

When it comes to gifting within a family business, however, Walker offers this caveat.

“We never advise making lifetime gifts in a vacuum,” she says. “It’s always in the context of the family situation and whether it’s appropriate for the next generation to receive them—for example, either because they’re not interested in the business, there are issues with their marriages, or you’re worried about in-laws…There are all kinds of issues that have to be taken into account.”

In addition to gifting during life, other planning techniques to minimize the impact of taxes include valuation discounts—a way to lower the underlying value of a business during the appraisal process—and purchasing life insurance to provide liquidity for estate taxes upon the death of the owner.

“Also,” says Walker, “if a family business owner wants to pass the business along to his or her family, but only some of the children are interested in it, how do you make equal distributions if you have the company going to some of the kids but not others? That’s also where life insurance can play a role.”

Finally, says Harmon, the IRS allows payment of estate tax liability over as many as 13 or 14 years if the business meets certain criteria, but “it’s pretty complicated and not always available. When it is, however, it’s very helpful and even if someone hasn’t done a good job of planning, it can avoid the need to sell a portion or all of the business to pay the estate tax.”

Connecticut Business & Industry Association (CBIA)

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