These scenarios typically occur when business owners fail to pay enough attention to succession and tax issues, and there are several situations retiring owners should consider prior to stepping down from their company.

First, owners should ensure their beneficiaries are equipped to handle every facet of a company, according to the Wall Street Journal. Too often, small business owners oversee all business operations personally, ranging from marketing and advertising to accounting and tax preparation. Failing to prepare beneficiaries for decision-making roles and set clear guidelines for who will manage which divisions can lead to infighting and poor business decisions made by unqualified individuals.

Another common, and costly, mistake is failing to account for changes in a business’s valuation when transferring a company. The value of a business can appreciate by millions of dollars over a short period, and procrastinating when it comes to transferring assets or taking advantage of the benefits and protections under trust law will result in a sizable increase in the amount of taxes owners will pay when they eventually hand over the reins. Business owners may benefit financially from developing a clear-cut succession plan years before they retire and researching several different trust options to reduce their tax liability, the Journal reports.

In addition, failing to frequently conduct valuations can lead to last-minute tax and retirement planning surprises for owners who may have over- or undervalued their companies. For both succession and estate planning purposes, securing an accurate appraisal and valuation is crucial.

Many business owners hope that the companies they have built will outlive them and help build a family legacy. Too often, however, business owners procrastinate when it comes: (i) to estate planning, (ii) to taking advantage of gift tax exemptions and (iii) to utilizing trusts – all strategies that can help keep a company out of probate court.

Businesses that fall into probate can be compromised significantly, as court proceedings can take anywhere from a few months to a year or more, according to Fox Business. Moreover, because probate court proceedings are public, every aspect of the company may be revealed, including the assets it holds and its financial standing. During this period, business operations are typically run by the executor of the owner’s will, or in cases where an executor is not specified, by an individual who is court-appointed to manage the responsibility. This can not only negatively affect the company’s bottom line and exclude family members from key decisions, but can also jeopardize relations with employees and customers.

One of the factors that may inhibit owners from estate planning is a lack of clarity on when they should begin. Because estate laws are subject to frequent changes, owners who begin making preparations the day they begin turning a profit will best protect themselves and their heirs, according to Fox Business.

Living trusts are one of the most common ways business owners can keep their business out of probate, since they allow the trustee to easily transfer assets in the trust to heirs and avoid disruptions in company operations. However, many business owners are getting more creative and seeking out different trust options that fit their particular business needs.

Proper estate planning can help ensure companies are passed down successfully. Data from the Family Business Institute finds that only about 30 percent of family businesses survive into a second generation.

The taxable estate of a holder of a GPA includes the value of assets subject to the GPA, while the taxable estate of a holder of an LPA does not. The rationale is that unrestricted use or access to property is akin to ownership and should result in estate taxation.

Joint powers of appointment (created after 10-21-42) are LPAs if the power may be exercisable only in conjunction with another person having a substantial interest in the property which is adverse to the exercise of the power by the holder. The regulations contain examples of what constitutes a general or limited power.

If, for example, Holder may only exercise the power with X’s consent, we must carefully evaluate if X is truly adverse to the Holder’s exercise of the power . Assume A creates a trust using a trust company as trustee. Income is payable to Holder; however, principal may only be distributed if X consents. At A’s death, the trust is divided equally among X, Y, and Z unless Holder, in his will, appoints in different proportions to X, Y, or Z.  Will X block a distribution to Holder if X can be cut out?  In this instance, X is not adverse to Holder.  If we eliminate Holder’s power to appoint to X, Y, or Z, then X is clearly adverse to Holder because every principal distribution reduces X’s share of the remainder.

What if we use a Distributions Committee (“DC”) in lieu of joint powers. A DC gives the power over distributions to a committee that includes non-beneficiaries in order to avoid estate taxation of any person holding power over distributions. DCs are common in Dynasty Trusts or Delaware Incomplete Non-Grantor Trusts (“DINGS”). A private letter ruling (PLR) sets forth the tax treatment of issues arising out of a particular set of facts and is binding upon IRS and the taxpayer requesting it. In 2002 PLRs,trusts using DCs included succession provisions that permitted beneficiaries to be appointed to the DC; however, the beneficiary could not participate in distribution decisions affecting him or her.  The 2002 PLRs ruled that DC membership did not cause a member to possess a GPA.

Then, in IR-2007-127, the Service indicated it was reconsidering these 2002 PLRs because the committee members could be replaced, thus conferring a GPA upon members of a DC.  Not all aspects are being reconsidered.

It appears that DCs remain an effective substitute for joint powers if beneficiaries do not replace departing members.

The Court ruled in favor of Home Concrete and Supply LLC after the IRS took roughly six years to launch an audit against the company for a Son of Boss tax shelter.

The case revolved around the sale of Home Oil and Coal Co., which had been sold in 1999 by its two shareholders, Robert Piece and Steven Chandler. The shareholders filed their 1999 taxes in 2000, and the IRS audited them in 2006 after determining that they used a pass-through company to increase their cost basis when filing. After the sale was finalized, the shareholders had just a $69,000 capital gain on a $10 million sale.

The IRS argued that an extended six-year time period to audit the company was warranted based on several lower court interpretations of tax law. The tax agency also noted that an extended time period to bill businesses for unpaid taxes was authorized when the amount exceeds 25 percent of their gross income. However, the Supreme Court disagreed and ruled the IRS was confined to the three-year deadline, setting the record straight after years of mixed lower court decisions and creating a significant precedent for business taxpayers.

Son of boss (bond and option sales strategy) tax shelters function by inflating the cost basis of an asset to avoid paying higher capital gains taxes. The IRS has historically gone after these shelters for tax evasion and been successful in many cases, sometimes recouping billions of dollars in taxes, interest and penalties.

The ruling is expected to impact several similar pending cases amounting to roughly $1 billion in taxes that are currently being argued in courtrooms across the country.

In July 2010, James and Theresa DeMuro, who owned and managed engineering firm TAD Associates LLC, were each indicted on one count of conspiracy to defraud the United States, and 21 counts of willfully failing to account for and turn over employment taxes, according to the New Jersey Law Journal. The couple received repeated warnings from the IRS between 2002 and 2008 that they may be held personally liable under tax law for the $546,242 they withheld from employee paychecks for Social Security, Medicaid and income taxes, but never turned over to the government.

In 2003, the IRS imposed penalties on the couple and required them to make monthly, rather than quarterly, payments of employment taxes. Further, the IRS set up a special trust for the company that the DeMuros were required to pay into. The couple then made frequent withdrawals from the account to cover non-business expenses and closed out the account without IRS permission, the law journal explained.

In U.S. v. DeMuro, prosecutors countered the DeMuros’ arguments that their failure to pay employment taxes was not willful by introducing evidence showing the DeMuros spent approximately $5,043,867 on lavish vacations abroad, vacation homes, vehicles, parties and home shopping network purchases during the period they failed to pay employment taxes. Following their conviction in 2010, the DeMuros appealed the decision, arguing their personal spending was irrelevant to their case.

The presiding judges relied on previous cases, U.S. v. Ellis and U.S. v. Blanchard, to rule that lavish personal spending can directly tie into a defendant’s case of willfully failing to meet their tax obligations.

District Judge John Padova, who sat on the appeals panel, offered the opinion that evidence of the DeMuro’s lavish spending on personal items “that they could have used to pay their taxes belies their assertions that they were sincerely attempting to pay back their taxes as expeditiously as possible.”

Any number of financial circumstances that may occur can derail an estate plan if they are not addressed before the year’s end, according to the Columbia Business Times. The most immediate changes involve births, deaths, marriages and divorces that have occurred or are likely to occur over the course of the year. This may prompt changes in succession plans and business trust arrangements.

In addition, changes in a company’s status will also weigh heavily on an owner’s estate plans. Retirement and selling off business assets will undoubtedly have an impact, but owners must also pay close attention to mergers and developing new business entities, the news source explains. New business arrangements can dictate what owners can leave to beneficiaries and have a profound effect on succession planning.

Lastly, changes in a business owner’s financial status due to asset appreciation, inheritances and income should be accounted for in the form of an updated estate plan. Oftentimes, owners may fail to monitor the growth in savings and other assets over time, which can lead to tax surprises once new estate laws go into effect.

The current estate tax exemption sits at $5.12 million; however, this amount is expected to fall to $1 million for both estate and tax exemptions in 2013. For this reason, estate and tax planning is critical this year, and businesses can navigate around any uncertainty by closely monitoring and updating their estate plans.

The government has litigated successfully against DVGC’s since 1944; see for example, Commissioner v. Procter, 142 F.2d 824 (4^th Cir. 1944).  The clause in Procter provided that any part of the transfer that because subject to gift tax because of IRS revaluation should be returned to the donor and should not be deemed to be part of the gift.  The Court held that taking back property (a “condition subsequent”) to avoid taxation violated public policy.

Although, Wandry is the fifth taxpayer victory in the DVGC area, it is the first case where the excess gift did not pass to a charity. Three of the taxpayer victories were won in Courts of Appeal in the Fifth, Eighth and Ninth Circuits. These taxpayers avoided the Procter rule by having the increase in value, resulting from an audit adjustment, pass to a charity and qualify for a charitable deduction rather than go back to the donor.

In Wandry, the parents transferred property to a limited liability company (LLC) and caused the LLC to be appraised. Then, the parents assigned a sufficient number of LLC units (percentage interests) so the fair market value of the units equaled the dollar amount of the gift next to the child’s name.  The parents filed gift tax returns using units rather than dollar values.  The court held for the taxpayers stating that the gift  was of the stated dollar amount rather than percentages (units) of the LLC.

There are different types of DVGC’s, such as formula transfer clause and formula allocation clause, each replete with nuances. Although use of DVGC’s is beneficial, it raises a number of other issues that and require careful planning. One such issue is the income tax consequences of an audit that changes the number of units of property transferred.

Wandry offers a type of insurance against revaluation upon audit, especially in the context of family limited partnerships and should prove useful to taxpayers.

Small companies and family-owned businesses make up between 80 and 90 percent of companies in the United States, and employ 62 percent of the workforce. In addition, small companies fuel roughly 64 percent of the country’s gross domestic product. However, statistics from the Family Business Institute reveal only 30 percent of family businesses survive into the second generation, and only 12 percent are still viable by the third, as a result of failed succession planning.

Further, only two-thirds of family business owners report having an accurate understanding of how much they may owe in estate taxes, and one in five owners admit to having no estate tax planning strategies in place, the institute noted.

Business owners also revealed the most common issues associated with developing a succession plan, including leaving the company to a surviving spouse, rather than younger beneficiaries, and creating a plan that would treat multiple children equally. Other smaller businesses often cite being too wrapped up in the day-to-day operations to plan for the future, University of Pittsburgh Small Business Development Center director Ray Vargo told the Pittsburgh Post-Gazette.

Further, experts say that business owners who were proactive about building and growing a company from the ground up may face succession issues if their children and heirs lack the managerial experience or will to keep operations going, the newspaper explains.

Because of these common obstacles, experts say that developing a succession plan early on that emphasizes the financial and tax aspects of transferring a company, as well as cultivating heirs to take on leadership roles, is a crucial element in keeping a company running.

The current $5.12 million gift tax exemption will expire at the end of the year and revert to $1 million in 2013, giving business owners a small time frame in which to pass on assets that are expected to appreciate in value before the changes go into effect. In addition, the 35 percent tax rate attached to federal estate, gift and generation-skipping taxes is expected to rise to the top rate of 55 percent.

One of the most common actions business owners are taking is making the lifetime gift of $5.12 million – or $10.24 million for married couples – to reduce their estates by the gifted amount and the appreciation of the gift over time. Lifetime gifts can be made in the form of business interests, real estate, assets and securities.

However, business owners are also taking advantage of trust options to transfer wealth to successors as a strategy for avoiding estate and gift taxes. Grantor retained annuity trusts are emerging as a popular option in that they allow business owners to retain control of business assets and income for a specific number of years before transferring the company over to heirs.

Longtime business owners are employing dynasty trusts to allow the assets in the trust to pass from generation to generation indefinitely free of estate taxes. The trust is an appealing estate planning option for businesses that undergo a great deal of change frequently, in that future generations are free from GST and estate taxes, but still enabled to make changes to the terms of the trust.

Negotiations over the sales price of a business are often difficult, because there is always risk that the enterprise will not perform after the sale as it has in the past.   In the context of a typical, closely-held business, the proceeds of sale represent a significant portion of the owner’s retirement fund and the owner does not want to sell too cheaply. The buyer, on the other hand, is concerned that the best days of the target business are behind it, and that he or she is overpaying.  A contingent sales price is one means of bridging the gap in price between the positions of buyer and seller.

There are three categories of contingent payments. The first is where a maximum sales price is determinable.  The second is where the maximum selling price is not determinable, but the period over which payments will be received is fixed. The last category is where there is neither a maximum price nor a definite term.  The buyer may then negotiate a cap on the earn-out while the seller may want a make-up provision that would permit the unused cap to carry forward to subsequent years.

What is sometimes overlooked in negotiations is that the seller’s basis (or tax cost) is recovered differently in each of these scenarios, because the profit percentage that is applied to each payment is different for each method.  Although a seller may want a large cap or upside, an unattainable figure will cause more harm. A large unrealistic cap will require that the seller recognize more income in the earlier years and will result in a capital loss at the end of the term.  This is because the profit percentage is overstated.

A seller should be aware of how basis is recovered under each proposal that is presented.  It is to the seller’s benefit to recover more basis in the earlier years of the payout period because this results in reporting less income.  Where the cap is exceedingly high and unrealistic, a taxpayer may be forced to apply for a private letter ruling to obtain relief from these distortions that occur when the profit percentage is overstated.