CONTINUING HIS LOOK AT SUCCESSION PLANNING FOR DEALERS, CHUCK SEGUIN TURNS HIS ATTENTION TO THE NUTS BOLTS WHEN IT COMES TO PASSING THE TORCH
For all of 2013, my articles have covered dealer succession. We have covered a wide range of topics but in none of them have I discussed how to get started and how to proceed.
We are soon starting a new year and in my mind there is no better time than now to get started reviewing your succession plan or for some of you, embarking on creating a plan.
For automobile dealers, succession involves five critical elements: ownership, management, family, brand and income taxes. All have a role to play and therefore all must be addressed in any plan.
The process starts with a contingency plan. The contingency plan answers the question: how will the business continue if something were to happen to me?
Planning for the unexpected is an absolute must. It goes well beyond buying insurance and really gets down deep into how the business will run if you are unable to run it. It considers disability, incapacity and death and answers a few simple questions, all surrounded around who will step in to take control of all business and personal related decisions.
Automobile dealerships must take into consideration the needs and requirements of the business, the brand, employees and family. I can tell you right now that all these groups have different rules and objectives. So don’t expect this to be easy.
Selecting who will step into your shoes, for some, is a very easy decision and for others, an agonizing one. Don’t forget choosing your own successor involves brand approval. There is no sense making elaborate plans around a specific individual if ultimately the brand is not going to approve this person as the dealer of the future.
Okay, lets assume that you have found your successor, the factory has agreed and you are now ready to start putting the pieces into play.
For those of you that want to deal with ownership, a common step in a family transfer is to enter into an estate freeze. This process involves transferring all the future growth of the company to your successor while at the same time allowing you to maintain control. You’ll need to engage an accountant and a lawyer to make sure this transfer does not trigger any untimely income taxes.
SHARES AND TRUSTS
The next decision to be made relates to your successor and how that person will hold the shares in your company. You have three general options: personally, through a holding company and through a family trust. There are different reasons behind each option. For instance, if your successor is to own more than 10 per cent of the common shares, and that successor has borrowed money to purchase shares, then a holding company might make some sense to take advantage of the tax free inter-corporate dividends.
In this situation, debt can be repaid by tax-free dividends, eliminating any tax erosion to retire debt. Another, for instance is where you have concerns over the stability of your successor’s marriage. In this case, a trust might be the better vehicle for your successor to hold the investment. It also could provide direct ownership by grandchildren thus allowing you to skip a generation. In any event, professional advice is highly recommended.
Conducting an estate freeze requires you to peg a value of the business being transferred. This same process allows you to pre-determine the income taxes due upon your death and allows you the opportunity to purchase life insurance to cover off this eventuality. Life insurance, used wisely, is a very important tool in succession planning.
As I mentioned previously, you still control the company in an estate freeze. Careful planning must take place to determine how you will withdraw funds you will need to fund your retirement on a tax efficient basis. In some cases, a combination of salary, dividends and share redemptions yields a good result when both your interests and the interests of your successor are taken into consideration.
PROPERTY CONSIDERATIONS
Up to now we have been talking exclusively about the dealership. However, most dealers have a significant amount of their wealth tied up in dealership property. Many dealers simply become landlords and use the monthly lease payments to fund their retirement. Please remember that these lease payments are subject to income tax and as such the full amount is not available for you to spend. Others sell the property to their successor and take back the mortgage and live off the monthly mortgage payments. Again, the interest portion is taxable and any capital gains reserves also become taxable over time. Recently many dealers have entered into sale and leaseback transactions. In this type of transaction you get to realize the value of your land and buildings in cash or securities and your successor enters into a long-term mortgage with an option to purchase down the road.
Finally I want to talk about recapture and the Capital Dividend Account. Recapture is when, based on a selling price higher than asset tax values but below your original cost, the company is taxed on all the tax depreciation it has taken over the years. For example, your building that cost you $1,500,000 sells for $1,500,000 but has been depreciated down to $1,000,000. The $500,000 difference is recaptured depreciation and is taxed at normal income rates. If that same building sold for $2,000,000 then in addition to the recapture, a capital gain will be realized; 50 per cent of which is included in normal income and taxed accordingly. The tax-free portion (50 per cent) goes into the Capital Dividend Account and is payable to shareholders tax free.
It is important to remember that one of your partners is the taxman. Income taxes must be factored in all situations so that decisions can be made on an after-tax basis.
Family succession is simple on the one hand and complicated on the other. Breaking the decisions into digestible chunks, in my mind is the best way to proceed. The process may seem very technical, however, in the end you must get to the result you started out to achieve. I would recommend that you read the CADA Dealer Succession Planning Guide — a roadmap to your future. It’s a good summary of the issues and covers many of the elements of dealer succession.
Getting started and updating your plan annually is one of your most important responsibilities as a business owner and head of the family. Don’t get bogged down with the technical jargon and legalities. With good advice, professionals can handle the technical stuff. Your job is to make sure, at the end of the day, your objectives have been completely and continuously satisfied.
