Tax Efficiency in Business Transitions: Strategies & Considerations with Eric Lake

Episode Description:

In this episode, host Elizabeth Ledoux is joined by Eric Lake, a Managing Tax Partner at Holben Hay Lake Balzer CPAs, an accounting and consultancy firm that is a division of SingerLewak. Tap or click the play button below to listen to: Tax Efficiency in Business Transitions: Strategies & Considerations with Eric Lake.

In this episode, Elizabeth and Eric discuss various strategies for business owners navigating business transitions and ensuring tax efficiency. Eric shares his insights as a tax professional, highlighting key considerations when transferring ownership from one generation to the next. They explore the importance of planning, tax implications of different sale methods, and creating a sustainable wealth-building plan for successors.

Be sure to listen to this episode to learn from Eric’s expertise in tax consulting and planning, evaluation and financial modeling of possible business ventures, and tax compliance. 

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Tax Efficiency in Business Transitions: Strategies & Considerations with Eric Lake Transcript

Eric Lake: When it’s a stock sale, all of the all of the gain is long-term capital gains, okay, as long as they’ve owned the company for more than a year, and that’s obviously 99.9% of the, of what we see. So all of it is capital gains from the seller’s perspective. And that means that you get anywhere from 15 to 23.8% long-term capital gain. The difference between those two percentages is 15% is for something that’s roughly less than a quarter of a million dollars of capital gain. So mostly it’s it’s going to be up in the 23.8% range.

Elizabeth Ledoux: Welcome to the business transition roadmap. My name is Elizabeth Ledoux. And through my years, I have seen how communities thrive. When business succession and transition are done. Well, me and my team at the Transition Strategists have been helping business owners develop and implement transition strategies for over 30 years. And on this show, we want to help you by giving you the roadmap to a healthy business transition. Let’s get started. 

Hi, everybody, and welcome back to the business transition roadmap. We are here today talking with Eric Lake who is the managing tax partner of singer Lueck here in Colorado. And I am so excited to have very clear he’s got so many years of working with private companies, helping them to navigate business transition, and from the tax perspective, of course, but also from a variety of others, just with all the knowledge and history that he has, over the many years. So Eric, welcome to our podcast today.

Eric Lake: Thank you, I’m, I enjoy being here.

Elizabeth Ledoux: Good. I’m so glad we’re here. So this is super fun for me. On top of Eric being the managing tax partner, he also is my brother. And I love being able to work with him at times and also tap into his knowledge. So he’s going to be really, I think, super transparent with us today with some things that he has seen in working with clients and how they’ve navigated an approach transition. So Eric, first, tell us a little bit about you and your history and your background as an accountant.

Eric Lake: Okay, well, as you know, Elizabeth is my sister. And we grew up in Denver, Colorado, and I have not really left the state of Colorado to live for ever really. So grew up in Denver, went to Colorado State University, got a degree in finance and real estate from the universe or Colorado State University and then I have a master’s in accountancy from the University of Denver. I’ve been practicing as a CPA since 1992. Been in the accounting industry and since 1989, when I was an intern with Coopers and Lybrand. I’ve gone through a lot of the the I started with the Big Four went to a small regional or smaller regional firm. Then I started my own CPA practice in 97. Bought a practice in 2002. Ran that for a few years merged in with another firm in Denver called Holden. Hey, Bowser, and that turned into Hovind Hey, Lake Bowser. And then in 2019 joven Hey, Lake balls are merged in with singer Lee black singer Lee Black is a is a West Coast Regional firm. We have about 435 people in our office, including administrative people. We are top 70 in the country and sides. And we do everything from tax work, audit work, bookkeeping, accounting work. We have a company that are a division that does franchising. For franchise companies. We virtually do it all we have a group that’s International in in nature, so a company that is going offshore, or a company that’s coming on shore, we have the ability to do Help them. And we also have have a group called salt, which is stands for state and local tax. And all they do is state and local tax issues, determining how to best in most efficiently file tax returns and make your way through all 50 states.

Elizabeth Ledoux: Now, well, in our background, yeah, that’s, that’s a lot. It’s a it is, it’s a great firm and a great group of people. And, you know, I think that for our practice today, you come at things from a couple of different angles, one and helping clients to navigate business transition. But second, I mean, you’ve been through quite a few business transitions yourself. So when you look at your clients, and you see people starting to navigate business transition, you know, trying to figure out how they’re going to move the company from their generation, their current ownership to a next generations ownership, whether it’s family or not. How do you see people starting to do that? What do they do?

Eric Lake: Typically, what what I see, and this is, hopefully, after they’ve kind of gone through what, what you can provide in the consulting, but typically, where I see that that happening is, is that the, the person that maybe started the business, or maybe even the second generation person at this time. They’re, they’re kind of, they’re, they, they want the business to, to thrive, past, you know, their, their ability to run it. And they look to maybe their children or key individuals that that are within the company, or both, really, in some cases, to, to kind of pick up that torch and, and move it forward. And often, the biggest issue that we have, from a tax perspective is what is the what is the entity that that is being transitioned? If you’re talking about transitioning from like a father to one of his children? Now we get into things like are we are we typically those will be more like a stock sale? And that creates? It, that’s probably the best possible way for a father or a mother to get out of their business and get it to their children.

Elizabeth Ledoux: Why Yeah, what about that is the best way for a father or mother to go to a child, when

Eric Lake: you’re selling stock, when it’s a stock sale, all of the all of the gain is long term capital gains, okay, as long as they’ve owned the company for more than a year. And that’s obviously 99.9% of the, of what we see. So all of it is capital gains from the sellers perspective. And that means that you get anywhere from 15 to 23.8%. Long Term Capital Gain, the difference between those two percentages is 15% is for something that’s roughly less than a quarter of a million dollars of capital gain. So mostly it’s, it’s going to be up in the 23.8% range. And that’s good for the seller from the buyers perspective, they kind of step into the shoes of the, of the seller, their father, their mother. And so they’re, they’re selling a company. And there’s, there’s not a lot of depreciation and other they’re buying a company and whatever depreciation they have, let’s say they have a bunch of old equipment, their manufacturing company, and they have a bunch of old equipment. There’s not really a lot of deductions for the purchase. There are ways that we can structure the transaction to alleviate that. But those some of those, those strategies adversely affect the seller. And so it’s really important to when you’re starting down this path, to get with your CPA, get with somebody like you Elizabeth, and strategize and figure out how we’re going to move these assets from one generation to another, at the most tax efficient way for and I’m talking about a father, mother, you know, to their children, the most tax tax efficient way to move this to the, to the next generation. And the the tax efficiency is at the family level, you know, the mother and father aren’t taking a big hit, and the child isn’t strapped, trying to pay the bills. So yeah, and that’s really, that’s a really important thing.

Elizabeth Ledoux: Yeah, and that’s interesting, because, you know, what I see at times, is, I see people going for the how and how much, right, so they kind of start there, sometimes with their advisors. And what I’m hearing from you, if I reflect back properly, is that it’s important to know who you want to transition this to, ideally. So that when you do go so that you have a little bit of a foundation, and you can go explore, with a little bit more accuracy, the tax consequences, and also, you know, some of the legal consequences that go around that, because in prior podcasts, we’ve talked a little bit about, we’ve talked a little bit about stock sales, which, you know, sale of the company with just sale of the stock or sale of the interest. We’ve also talked a little bit about assets, sales, and asset sales just are, they’re different. And it’s where the assets get sold out of the company, and then the company either has to be you can do something else with it, or you can dissolve it. The interesting thing is, you’re what you were talking about with that, with your thoughts are tax efficiency, the best way to go from parent to child in a tax efficient manner. Because other people, they’ll talk about gifting and other things like that. So let’s say you were to gift to somebody versus sell the stock. Is the gifting strategy better in a way? Or how does that compare to what you just talked about?

Eric LakeSo that gets into the realm of, of a lot of estate planning issues, it depends on how big the sale is, and what the parent has done in the past, as far as gifting is concerned, you can definitely gift most you could gift any company, you know, all the stock, etc to the child, and that would be very tax efficient. Today, all right. As long as the sale isn’t, you know, $50 million. Because what, if the sale is too big, or the gift is too big, say more than $20 million. Now we are 25 million. Now we get into the fact that you’re gonna gift off the all of these assets or these interests to the child and create a 40% tax rate to the mother and father, because they have to pay the gift tax on it. All right. If it’s a $12 million sale, and there’s a mother and a father, you could gift it, or 20 $12 million value, I should say. You could gift it to the to the child or children, and basically use up a bunch of your gift tax exemption and transfer it to the children virtually tax free. All right. Now, when I say virtually tax free, we haven’t really gotten past the tax, all we’ve done is moved the stock or the assets or whatever you gifted to the child, they step into the same into your shoes from a tax perspective. And so if they were to sell the company, you know, three months later, whatever capital gains that they have, or that was transferred to them that was deferred, they would then get to pay. So they don’t get a what we call a step up in the basis of those assets. That only occurs at death. Right. So probably the most tax efficient way to do it, is to hold on to the stock. All right, create maybe some sort of profit sharing plan for your children that they can share in the profits of the company. And there’s ways to do that, depending on the type of entity Do you have, and then at death, you transfer the actual shares of stock to them. And you can use your 12 to $13 million depending on when you die, to shelter, the capital gain on the sale of that company,

Elizabeth Ledouxright on that transfer, because because the key to that whole conversation, well, a couple of things that you know, take aways is, the Step Up happens with current law, if I’m reflecting back properly, step up happens with the current laws at the time of death, and it does not happen before. So holding on to that stock, if you’re going to gift it, potentially is one strategy that might be that might be workable. One of the things that is lost in that which is the one of the things that’s lost in that strategy is the ability for the successor to create wealth for themselves. And so that’s where that profit sharing comes in. So they can take some of the proceeds out of the company as though they did own it. But the actual transfer of the equity value takes place later.

Eric Lake: Correct. Yeah. And if you’re, if you’re talking about something like an LLC, or a partnership, you can actually create it, they’re called carried interests. And the parents can gift carried interests or profits interests, in the partnership, at a $0 value. Because all you’re giving your child on the day that you give it to him is the opportunity to make money in the future as a partner, so you’re giving them a three or five or six or 15%, profits interest, and it doesn’t have a value on the day that you gifted it to them. Okay. And the only way that there’s value there is, as you make money in the partner, as a partnership makes money and they issue a k one to the child, the child will pay tax on that, and then they can build their their capital accounts and their bases stock bases in the company over time, and they’re only their gift is the is the amount that that they’re paying tax on every year through the k one. So and that actually kind of dilutes the the parents interests as a way to shift money.

Elizabeth Ledoux:  That’s great. So we’ve talked a little bit in the past about just the, the need to potentially start with the what I call the four w’s the who, the why, the what and the when. And I think, you know, whenever in all honesty, when I start talking to Eric, and also other tax people, there are so many things to keep in mind of when you’re thinking about the tax efficiency of any transition, you’re trying to figure out, you know, what type of entity Do you have currently? How would you like to get it transitioned and to how many people and sometimes there are partners. And so that strategy is a little bit different tax wise, then maybe to a son or a daughter, or a family member. And so, and then, so many different ways to get them going. The other thing they think that’s interesting is there is always and I’m finding it to get, it’s getting bigger, the age of the people who are the current owners, they’re living longer and working later in life, and they’re having a good time doing it. And then the successors who would normally be their successors are older, because you know, especially if it’s a parent child kind of a thing, those they’re about 25 years or so apart. And so if the father or mother works until they’re 70, or even 80, sometimes, and it doesn’t give the successor the opportunity to create the wealth that they want to. And so I think that in the strategy, if you’re putting people first and taking care of people, it’s important to think about what happens to the successor and how they create their wealth and also learn about the tax opportunities that are there for them. I’m sure you’ve seen a little bit of tension in that area.

Eric Lake:  Yeah. You know, in the piece that I think is is that we as tax professionals don’t really think about too much, unless, you know, you’re you’re in the middle of it is. You know, what is the what is the father or the mother want out of this, you know, there’s a, there’s a retirement piece to this that we don’t really talk about. And so we have to figure out what the what the parents need out of it. And,

Elizabeth Ledouxor even a business, it’s transitioning to, right, whether their parents are exactly where you need to retire.

Eric LakeExactly, what do you need to retire? And that’s a huge, huge issue, it’s, that’s probably the biggest issue that I’m gonna call him the seller has is, you know, I’ve worked all my life to build this thing. This, this, you know, money tree, if you want to call it that. And now I need to start harvesting some of this for, for me, but I want somebody else to help me harvest that. And so we’ve, we’ve got to get that in place, as far as the, the successor is concerned in some of the tax strategies for the successor is, you know, is there a way that we can defer some money out of the corporation for their retirement, all right, and that’s building their wealth, so that when they get to the age of their, of the seller, they have the ability to pass the corporation along, or the business long, and they might not need, they may need about as much as the prior seller has, because we’ve developed a strategy to basically pull some of that money out and put it aside for them. So that that, that they have money to live on, you know, irrespective of what the business is worth. And that’s really important.

Elizabeth LedouxYeah, I think that’s great. So two questions for you one. How many of the clients that you work with that are private business owners, so they can be families or non family? So either way, but private companies? How many of them have a well diversified? asset base? So, you know, not all of their money is in the company? What would you say?

Eric Lake: I would say that it’s probably close to 5050. Yeah. And, and, you know, well diversified is a is kind of a moving target. Because if your company is making net income of $300,000, the amount that you have to have outside of, of your company, to be, quote, well diversified, is a lot less than a company, that’s $50 million. And so it’s, it’s kind of a moving target. But

Elizabeth Ledouxyou mean, from an asset standpoint, that’s true, but from a life

Eric Lake:  from an asset standpoint, it’s from a life standpoint, it’s, it’s yeah, it’s exactly right. If your company isn’t making very much money, you better have a lot stashed away, if you can, you know, share. Yeah. Because you’re just you’re just not going to be able to get the money that you need out of it to survive. You know, whereas if your company’s a $50 million company, you’re probably going to come out of the out of the transaction with a lot more money than what you would have in other investments. Correct. So, yeah,

Elizabeth Ledouxyeah, that’s an that’s very interesting, because, you know, most statistics are that 80% That 80% of business owners wealth is typically tied up in their company. And the other thing about how to leave that it’s amazing. How often Yeah, well, and to that point, you know, business owners when they’re building, when they’re building their wealth, tend to invest in the thing that they know best, that they think that they do best and so you reinvest in your business and reinvest and reinvest and reinvest thinking that you’ll be able to cash it out sometime. And if you’re intentionally think that that’s absolutely possible. And that’s why also I like the timeline idea, because I was going to ask you how, how many owners? Or what do you think of when you look at owners that are thinking about transitioning, that kind of know what their business is worth, and also understand the tax consequences of if they go to sell to a third party or to someone else, maybe even a partner.

Eric LakeI would say that, that the number of people that actually say, five or 10 years out, start to look at the value of their company, and try and figure out what, what their company is going to be worth. On the day they retire. And their five or 10 years out, I would say that’s a very, very small number of people really small. It’s sad, but that’s probably the case. Because what, you know, entrepreneurs, I think, are kind of a funny breed. They invest in themselves, they invest in the fact that, you know, they can get whatever they they’re doing done. And sometimes they don’t worry about the future of their retirement, when it looks when they’re looking at their business, per se, they’re more interested in running it and being in there and doing what they do best. And that’s running that business. And those decisions are hard, and maybe sometimes even painful to think about. You know, it’s, it’s kind of like, you know, selling your first child, you, you just don’t want to think about that. You know. So

Elizabeth Ledouxthere are there are a lot of relationships that are inside of the company that you care for as an entrepreneur. And the other thing, I think you’re right, Eric gets a, it is can be kind of sad, because it’s the is the end of an era, in a way, it’s the end of you as the entrepreneur building and growing, it could be the beginning of a next era of you being a mentor, teacher helping somebody else to take it forward, and letting go. And it also could also be the beginning of your next adventure. But some people don’t want to do that. And I was talking to a potential client the other day, and there’s nothing wrong with having a 20 year timeline, where you’re gonna hang on to some of the assets, right, you’re gonna hang on some of this stock, or whatever it might be, even until you pass and I, you know, my belief is, as long as there’s a strategy for your family, to know what to do with the business, whether they’re taking it over, or whether they’re going to sell it and transact it to somebody else. As long as there’s some kind of a strategy and people now, I don’t think there’s anything wrong in continuing to own it until you’re no longer on the planet. It’s just my belief. So,

Eric Lake: I, I personally think that having that first or second generation person around, and, you know, it doesn’t have to be that they’re, you know, in the middle of it when they’re in their 70s or 80s. But, you know, I love the fact that Bill Holden and Craig hay, who are my, they’re now my retired partners, we still have offices farm, they still come in occasionally, they still help us and consult with us on some of our client work. You know, and they’re just, they’re just, they’re there. And that’s part of that mentoring and, you know, passing it along. And so I thoroughly believe in people, you know, that first or second generation holding on to a little of that of the, of the business and and being a part of it, I think it keeps them vibrant. And I think it allows the next generation to move into the those management and leadership positions in a a little slower manner than you know, I bought I sold this to you, it’s yours now and good luck.

Elizabeth Ledoux: Thank you. Yeah, well

Elizabeth Ledouxso, to in order to do better, I can you do have a great track record with that. And thanks for sharing that. It does require that you that you’re able to keep the relationships intact. It’s no fun to be in an environment where the relationships are tense and that and so it’s great to be able to keep the relationships intact and walk through it together, right, both the leaving generation and the incoming generation. So I have two more questions for you, that will be at our time. So what do you see as the number one roadblock when business owners start to think about creating a transition strategy or leaving their company’s number one roadblock?

Eric Lake: I think the biggest roadblock I’ve seen is actually I think the biggest roadblock is the fact that that, you know, this was their, this was their baby, this was the thing that they did. They did really well. All right. And a lot of the really successful people that are entrepreneurial, all right, they, they did something that they were passionate about. And now all of a sudden, they’re in a position where they’re going to try and liquidate that position. All right, so they can retire. But it leaves a hole in, in their day to day life. Yeah, you know, they just maybe don’t know what to do with themselves. And that’s a scary thing. And they’re afraid that whoever they turn it over to, may run it right into the ground. Both and fear, that would be tragic, what

Elizabeth Ledoux:  I said, both really big fears and valid fears. Right, that’s what’s the next adventure and what’s going to keep them fulfilled, then what happens if you leave that and you leave it in somebody else’s hands, and then the whole thing is run into the ground, as you said, or just falls apart, just because of the lack of knowledge and leadership potentially, with a successor. And the, I think, the longer the runway, you give yourself as a business owner to walk through the transition and to stick around with your successor, the more likely your successor is going to be able to run it, it’s a long learning curve, to be able to do what you’ve done. Especially if you’ve done it for a long time. 10 or 20 or 30 years, you’ve got a lot of history under your belt and takes a long time for the successors to figure all that out.

Eric Lake: That is true. They know and, and, quite honestly. I have a I have a retirement time, that’s kind of mandatory in our practice. And I was just talking with one of my administrative people. And I’ve identified a couple of my younger leaders, and I’m working with them to, to get them up to where they can be, they can take my place. All right. And this has been going on for a year that I’ve been doing this, and I still have another like seven years until I have to retire. So the goal is is I want to work myself out of a job. Generally, that’s I want to be able to step off the big ship onto my little boat and go do what I need to do. And it may mean that I have to work till I’m, you know, 78 as a contractor for them or not, not 78, let’s say 70 As a contractor for my firm, so that we can get this transition worked out the right way. And I’ll enjoy doing it.

Elizabeth Ledoux: That’s awesome. Okay, so last question. We’re at our time, what one thing if you could leave it with our listeners and our audience? What one thing would you recommend for them to think about in their transition, their business transition?

Eric Lake: One thing

Eric LakeI think the one thing that that they need to think about is who is there who is on their transition team? Both accountants, lawyers, consultants, and the people that you’re going to, you’re transitioning to, that’s your transition team. And you’ve got to make sure that those people are rock solid, solid.

Elizabeth Ledoux: Yes, thank you. And I’ll pulling you in your direction, too. Right. They’re all on your boat. You’re all on your team. Yeah. Well, good. Well, Eric, thank you so much for not

Eric Lake: they shouldn’t be on the team. Yeah, you know,

Elizabeth Ledouxand on that note there There are quite a few business owners that think that they’ve got the right people and the team is telling them what to do. And they have an advisor that keeps on pulling them out of where they want to go as an owner, you know. And so thinking about, it is so important that there’s harmony with your team. There’s harmony with your successors, and all of your advisors and that you’re all moving in the same direction. So if you feel somebody’s not doing that with you, Eric’s right. They should not be on your team. Absolutely. Yep. All right, Eric. Well, thanks again for joining us, and I so appreciate you taking the time to be Elizabeth. It was awesome.

Eric LakeThank you so much. I look forward to it.

Elizabeth Ledoux: Thank you for listening to this episode of the business transition roadmap. If you are listening to this and you find yourself wanting to go deeper into these topics and start the process of putting together your transition strategy. I’d love to offer you a free initial strategy session with my team, where we’ll help you to explore the future transition of your business, head over to www dot transition To schedule a call. Thank you again for listening, and I’ll see you on the next episode of the business transition roadmap.


The Business Transition Roadmap with Elizabeth Ledoux

How do communities thrive? When businesses experience healthy growth and transition. Join CEO of The Transition Strategists, Elizabeth Ledoux as she and her guests identify what makes a successful business transition roadmap. If you know you want to transition or exit your business “one day”, today is the right day to start planning. This show will give you the roadmap.

If you’ve enjoyed this podcast, you can check out other episodes here: Podcasts – The Transition Strategists
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