CWS CWS Business Succession Planning 2 — Questions and Answers
Question 1: A grantor retained annuity trust (GRAT) is most effective as a succession planning tool when which condition is met?
- Interest rates are high and the business is expected to decline in value
- The business appreciates significantly above the IRS Section 7520 hurdle rate (Correct answer)
- The grantor is in poor health and unlikely to outlive the trust term
- The estate is below the federal exemption amount
Correct answer: The business appreciates significantly above the IRS Section 7520 hurdle rate
A GRAT transfers to heirs only the value by which the trust's assets appreciate above the IRS 7520 rate, so strong appreciation results in a large tax-free transfer.
Question 2: What is the primary purpose of a business valuation in succession planning?
- To set the price for employee stock purchase plans only
- To establish a defensible fair market value for gifting, estate, and buyout purposes (Correct answer)
- To minimize quarterly income tax payments
- To comply with SEC regulations for public companies
Correct answer: To establish a defensible fair market value for gifting, estate, and buyout purposes
A business valuation establishes a supportable fair market value used to structure gifts, fund buy-sell agreements, and support estate tax returns.
Question 3: Which business succession tool allows a business owner to sell the company to employees while receiving tax-advantaged proceeds?
- Family limited partnership
- Employee stock ownership plan (ESOP) (Correct answer)
- Section 1031 exchange
- Installment sale to a charitable remainder trust
Correct answer: Employee stock ownership plan (ESOP)
An ESOP allows owners of C corporations to sell their stock and, under IRC Section 1042, defer capital gains by reinvesting proceeds in qualified replacement property.
Question 4: Under the IRC Section 303 redemption rules, what tax benefit is available to a closely held business owner's estate?
- Capital gains rates on sale of all business assets
- A stock redemption treated as a sale (capital gain) rather than a dividend, to cover death taxes and expenses (Correct answer)
- Full estate tax exclusion for business property
- Penalty-free early withdrawal from retirement accounts
Correct answer: A stock redemption treated as a sale (capital gain) rather than a dividend, to cover death taxes and expenses
Section 303 allows a corporation to redeem a deceased shareholder's stock as a capital gain (not a dividend) to provide liquidity for estate taxes and administration expenses.
Question 5: What is the 'installment sale' method in business succession planning?
- Selling the business at a discount to the next generation in a single transaction
- Spreading business sale proceeds over multiple tax years to defer and potentially reduce capital gains taxes (Correct answer)
- Using a 1031 exchange to acquire replacement real estate
- A leveraged buyout by a private equity firm
Correct answer: Spreading business sale proceeds over multiple tax years to defer and potentially reduce capital gains taxes
An installment sale spreads recognition of gain over the payment period, deferring capital gains taxes and potentially keeping the seller in a lower tax bracket each year.
Question 6: Which legal document governs the terms under which business ownership is transferred among partners or shareholders during life events?
- Letter of intent
- Operating agreement or shareholder agreement with buy-sell provisions (Correct answer)
- Assignment of benefits form
- Articles of incorporation
Correct answer: Operating agreement or shareholder agreement with buy-sell provisions
A shareholder or operating agreement with embedded buy-sell provisions establishes binding transfer terms triggered by death, disability, retirement, or voluntary sale.
CWS CWS Business Succession Planning 2
A grantor retained annuity trust (GRAT) is most effective as a succession planning tool when which condition is met?