CEA Business Succession Planning 2 — Questions and Answers
Question 1: Which valuation discount is most commonly applied when transferring a minority interest in a closely held business?
- Marketability discount
- Minority interest discount (Correct answer)
- Blockage discount
- Key-person discount
Correct answer: Minority interest discount
A minority interest discount reflects the lack of control a minority owner has over business decisions, reducing the value of the transferred interest.
Question 2: Under a cross-purchase buy-sell agreement with four partners, how many life insurance policies are typically required?
- 4 policies
- 8 policies
- 12 policies (Correct answer)
- 16 policies
Correct answer: 12 policies
In a cross-purchase arrangement with n partners, each partner must insure every other partner, requiring n × (n-1) policies — with 4 partners that equals 12.
Question 3: A grantor retained annuity trust (GRAT) is most effective in business succession when the business is expected to do what?
- Decline in value steadily
- Appreciate significantly above the IRS Section 7520 rate (Correct answer)
- Generate stable but low dividend income
- Be sold to a third party within two years
Correct answer: Appreciate significantly above the IRS Section 7520 rate
A GRAT transfers appreciation above the 7520 rate to heirs gift-tax free, making it most powerful when the business is expected to grow rapidly.
Question 4: Which entity structure provides a step-up in basis for all assets at the death of a partner who held more than a 50% interest?
- S corporation
- C corporation
- General partnership with a Section 754 election (Correct answer)
- LLC taxed as a corporation
Correct answer: General partnership with a Section 754 election
A Section 754 election allows a partnership to adjust the basis of its assets when a partner's interest is transferred, including at death.
Question 5: An installment sale of a business to a key employee is LEAST likely to be structured using which of the following?
- A promissory note with interest at the AFR
- A self-canceling installment note (SCIN)
- A private annuity
- A charitable remainder trust (CRT) (Correct answer)
Correct answer: A charitable remainder trust (CRT)
A CRT benefits charity and provides income to the grantor but is not a mechanism for transferring business ownership to a specific employee.
Question 6: What is the primary advantage of using an Employee Stock Ownership Plan (ESOP) in business succession?
- It eliminates all capital gains taxes for the selling owner
- The selling owner may defer capital gains by reinvesting in qualified replacement property under IRC Section 1042 (Correct answer)
- It provides a step-up in basis for all transferred shares
- It bypasses all estate tax on the business interest
Correct answer: The selling owner may defer capital gains by reinvesting in qualified replacement property under IRC Section 1042
Under IRC Section 1042, a business owner selling to an ESOP can defer capital gains tax by reinvesting proceeds in qualified replacement property (QRP).
Question 7: A 'wait-and-see' buy-sell agreement is best described as one that:
- Delays the purchase price determination until a triggering event occurs
- Gives the business and remaining owners the option to purchase before a third-party buyer can (Correct answer)
- Requires an annual appraisal to set the price in advance
- Transfers ownership automatically upon a trigger event without a formal purchase
Correct answer: Gives the business and remaining owners the option to purchase before a third-party buyer can
A wait-and-see agreement gives the entity the first option to purchase, then surviving owners, and finally allows an outside sale if neither exercises the option.
CEA Business Succession Planning 2
Which valuation discount is most commonly applied when transferring a minority interest in a closely held business?