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Case Study: How A Business Owner Saved Big on Taxes

Case Study: How A Business Owner Saved Big on Taxes

April 16, 2021

By Rick Hellberg, ChFC®, CLU

The Client

For 40 years we have been working with John, a contractor with unique challenges as a business owner. He successfully built not one, but two contracting businesses. The first business was with two other business partners, the second business with his two sons. 

In each instance, the challenges we worked through surrounded exit strategies for John from the businesses when the time was right. We are going to take a look at those situations to give you some ideas of what to look out for when planning for your business.

Round 1: The Partners

When John and his partners first came to us to make sure they were setting up their business to succeed, we saw a big red flag that they weren’t seeing. They didn’t have an exit strategy. There was a simple explanation: each of them was convinced there would never be a reason to leave!

Here comes lesson number one: You must plan for the future as if it might not be what you expect it to be. Every venture starts out with the best intentions and the highest hopes. If you didn’t think everything was going to go according to plan, then you would make a different plan! 

We outlined what could happen and how each option affected them and they began to understand that they needed to determine the valuation of the business and create a buyout plan. Wouldn’t you know it, 6 months later one of the partners decided to leave. 

In fact, it was only about 5 years later that John himself decided he wanted to make a change. Because they knew the valuation process for the business and had established a protocol for a buyout, they knew what needed to be done. The challenge now was that the last remaining partner didn’t have the capital to afford the buyout. 

This leads us to lesson number two: Anytime you have a buy–sell agreement, the chances that it will work exactly the way you wrote it are slim. Concessions and adjustments will almost always have to be made because life rarely goes according to the plan. Plans are guardrails and guidelines to prevent going off a cliff, but they need to have some flexibility to accommodate the unknown factors. 

In this case, because John wasn’t ready to retire, we devised a workaround with the company CPA and attorney where a company subsidiary was given to John as a down payment. The remainder of the company buyout was paid in installments over time until paid in full. 

Round 2: The Family

Fast-forward 15 years and John has grown that small subsidiary into a highly successful construction business. Now he was ready to sell the company to his sons, and we worked with them to create an exit strategy. 

When dealing with a family buyout, there are three things to keep in mind.

  1. Make sure the person leaving is replaceable. If John wouldn’t have been able to trust his sons to make decisions without looking over their shoulders, then the business would not move on without him.
  2. Make sure the people taking over share the same vision as the ones leaving and that they complement each other. Would one son be able to handle ops while the other handled sales? Would there be constant conflict about the direction of the company or the roles each new owner would play? 
  3. Make sure the business can provide the revenue needed to provide for the retiree. Is the business able to survive the buyout, or will it be crushed under the weight of that expense?

We worked again with the company attorney and CPA to work out a plan that would be as beneficial as possible for both John and his sons. We again went through the options; if they sold to the boys, his sons would have to pay after tax and John would have to pay capital gains tax on the proceeds. Because of union restrictions, we couldn’t defer his taxes indefinitely, but we could help him minimize the taxes due. Even with that tax benefit, John decided to take a deferred compensation plan where he would continue to draw payments from the business over time. He would have to pay ordinary income taxes on the payments, but his sons could deduct the payments, which meant more to John than the tax benefits. We were able to arrange the payments in a manner that reduced John’s federal taxes by 25%. By doing so, John and his wife were so comfortable with the income stream they would receive, they decided they could give their sons the remaining value of the business instead of selling.  

John received what he valued: a guaranteed income stream over his retirement sufficient to meet all of his needs and the knowledge he was able to give his sons a legacy asset in the most tax-advantaged way possible.

We Can Help You

Here at PeterAlexander, we work regularly with clients to help navigate unique situations like the one we’ve discussed here. If you want to make sure you have a sound exit plan or business strategy in place, we’d love to work with you.

Reach out to us today at 610.940.1441, or email us at info@peteralexanderinc.com.  

About Rick

Rick Hellberg is president and CEO of PeterAlexander, a financial planning firm founded in 1991. Rick is passionate about providing quality, objective financial solutions so his clients can pursue their financial goals and create the legacy they desire. He strives to equip his clients with comprehensive financial services and advice so they can be empowered to make sound financial decisions. The plans Rick and his team develop help their clients to reduce their taxes, educate their children, fund their retirements, pass their businesses on at fair value, and create programs to attract and retain valuable employees, all so that they can focus on what matters most to them. Rick has a bachelor’s degree in liberal arts from Penn State, along with the Chartered Financial Consultant® (ChFC®) and Chartered Life Underwriter (CLU) designations. He has spent over 40 years working with successful individuals and designs tailored solutions to meet his clients’ unique needs. Rick resides in Philadelphia with his lovely wife, Lisa, and their two Shiloh Shepherds, Bentley and Winston. He is also the very proud father of two wonderful young men, Peter and Alex. In 2010, Rick ran for Congress in the 2nd District of Pennsylvania and has stayed active in local politics. To learn more about Rick, connect with him on LinkedIn.