The Tax Cuts and Jobs Act (TCJA), Public Law No. 115-97, affects many industries in many ways and a great deal of the changes are providing significant impacts to small businesses in the U.S. Inherent in the modifications is an effort to keep more business in the U.S. and foster continuous economic growth. As many of TCJA’s provisions were effective in 2018, it is important for both large and small entities to understand how they will be impacted, what to expect and how to plan for the future.
Succession planning is essential to keep a business vital into the future as ownership or management transition from one generation to the next. As the market continues to reshape and evolve, family-owned businesses will experience the need to significantly modify or establish substantial succession plans to cultivate future leaders.
Unique to each company, a succession plan effectively addresses its vision for the future – there is no one-size-fits-all. These plans reduce the impact of ownership/management transition on their employees.
An established plan must (1) consider immediate or impending openings in leadership, (2) provide a timeline to train and cultivate future leaders well in advance and (3) establish a leader to regularly check and ensure outlined goals are achieved. Succession planning encapsulates a plan for the proper quantity and quality of successors in the event of retirement, death, serious illness or promotion.
For effective implementation, owners/managers appoint successors who encompass a deep understanding of the vision of the company – both current and future – and have pronounced dedication to the company, its mission and its core values. Hadelman & Spitaels-Genser (2005) noted that, “A succession plan supports an organization’s strategic goals. What an organization cultivates in existing leaders—and looks for in new [leaders]—depends on its future plans.”
Construction Industry Strife
Throughout the construction industry, human resources are the most essential assets. Unfortunately, there has been insufficient research conducted for maintaining, cultivating and replacing these resources, and many construction companies operate without a succession plan – putting the future of the company at risk.
For large corporate construction companies it is less of a challenge to appoint a successor, with a larger pool of qualified candidates to pull from. However, for family-owned/closely held businesses (which make up the majority of the industry) there tend to be fewer and less qualified leaders to choose from. For these founding entrepreneurs to leave on their own terms, it is crucial to have a successful exit strategy in addition to a detailed succession plan to ensure the exit occurs in the most tax efficient manner. If the exit strategy and succession plan do not align, successful succession can be hindered or excessive taxes can be incurred.
Tax Reform Resets Equilibrium
TCJA significantly increased estate, gift and generation-skipping tax exemptions to $11.18 million for an individual and $22.36 million for a married couple. The exemptions are effective for tax years beginning Jan. 1, 2018, and provide annual increases for inflation through the sunset date of Dec. 31, 2025. This, among many other modifications in TCJA, will create an opportunity of flexibility for family-owned businesses planning for the transfer to the next generation.
Under new law, many family-owned businesses are focused on utilizing these new opportunities to prepare for the next generation’s success. Business owners are now able to make considerable gifts to family members in an attempt to transfer more of the business to the next generation – free of any gift or estate tax. This tactic transfers twice as much business value, compared to 2017, to children or trusts that will not be included in the business owner’s estate (or subject to the estate tax) when passed down. This change may ease some of the complexity around succession planning for many family-owned businesses – eliminating the estate tax altogether, in some instances.
Every entity will be impacted differently with the adoption of TCJA. Strategies may include retaining certain types of assets (i.e., income producing assets), and maybe gifting other types of assets (non-income producing assets), and others may include using trusts for tax planning. It’s critical to discuss options with a trusted tax advisor to see where hidden opportunities may exist within TCJA.
It is important to note that this is only one component to consider when planning for the succession of a business, and these opportunities may change at any time if Congress and the Administration further amend the federal transfer tax laws. Putting a comprehensive and capable management team in place can greatly assist in these transitions.
Types of Succession Planning Deals
Designated replacements are appointed, qualified and trained employee(s) who will be able to immediately step in and perform the duties of the role. This type of plan is usually implemented in the case of an unexpected transition – typically due to death or illness.
Target date replacements are similar to designated replacements but do not require the employee(s) to be fully trained. This type is used when a business can foresee the transition of ownership – usually due to retirement. As the transition approaches, the field is narrowed to a single, adequate candidate.
Situational replacements are set in place for uncertainty or a declining situation. Unlike the aforementioned types, situational replacement is not “role-specific.” This plan typically sources from within the existing pool of employees and is the most cost-effective. Often, the successor is chosen based on performance reviews, training programs and attributable skills.
Steps To Take
- Begin with the end in mind. Sooner is better – plan four to five years ahead of an anticipated transition to ensure a successful outcome.
- Commit to implement – allocate the appropriate time and resources. Create a team (family, leadership team, advisors/peers, professionals).
- The increased exemption amount may not surpass its sunset of Dec. 31, 2025. If your business engages in gifting business interests, you should consider increasing the amount and number of gifts in the coming years.
- Be aware of other considerations – Tax Implications, Operational, Financial and Cultural change.
In closing, Hadelman & Spitaels-Genser advise that, “A succession plan is not something that, once complete, is put to the side. At a minimum… revisit the plan annually.”
Hadelman, J. & Spitaels-Genser, E. (2005, September). Succession planning: The art of transferring leadership. Trustee, 58(8), 15-19.
Dalton, C. M. (2006). A recipe for success in succession planning. Business Horizons, 49, 175-177.
Download a printable copy of this article by visiting DHG’s website.
Mike Trammell is the Managing Partner of Dixon Hughes Goodman’s Spartanburg, S.C. office and serves as a leader of the Dixon Hughes Goodman Construction Group. Mike has over 30 years of experience working as a trusted advisor to contractors of all types and sizes. Trammell also served as controller and CFO of a general contractor giving him an “inside” perspective. He also holds a South Carolina General Contractor’s License.