# A Real-Life Tale of Two Cities

Two Business Succession Plan Thrillers: One Doom, One Boom

It’s often true: Real life is stranger than fiction. Here are two true-client tax stories with almost identical facts involving transferring a family business to the children. One caused a financial-tax train wreck, the second a tax-free victory.

If you own all or a portion of a closely held business and are about to (or will someday) sell/transfer your interest in the business to one or more family members or employees, read this article carefully. You’ll learn the wrong way and then the right way to make the transfer, and save more taxes—income, capital gains and estate combined—than the actual fair market value of your business interest being transferred.

Both stories started with a phone call from a column reader. The first call came from Joe in Chicago, IL. Here’s Joe’s story:
About a year ago, Joe sold 100% of his business, Success Co., to his son, Sam, for \$5 million, payable by Sam over an 8-year period, plus interest. Joe’s tax basis of Success Co. (started by Joe 28 years ago for \$9,000) was near zero, so for our purposes we’ll assume his tax basis is zero.

Let’s take a look at the tax damage when Joe sells his Success Co. stock to Sam. To make it easy to follow the number, let’s assume the price is \$1 million and both Joe and Sam are in the highest tax bracket. Also assume the combined (state and federal) income tax rate is 40% (5% state and 35% federal).

Now let’s follow the tragic numbers. Here’s how you figure the tax cost for the \$1 million price: 1) Sam must earn \$1,666,000 (rounded) and pay \$666,000 in income tax (40% × \$1,666,000). So, Sam has exactly \$1 million left, which he pays to Joe. 2) Joe must then pay \$150,000 in capital gains tax (at 15%) on his \$1 million sales price. Sad, but Joe only has \$850,000 left after taxes. The tax loss to the family is \$816,000 (\$666,000 + \$150,000) for the \$1 million stock price. A lousy deal!