John Fox Arnold, Chairman of Lashly & Baer, engages in corporate and municipal law and finance. He is a former President of The Missouri Bar and of the Bar Association of Metropolitan St. Louis, and a former member of the House of Delegates of the American Bar Association. He is currently a member of the Family Firm Institute and the Attorneys for Family-Held Enterprises.

Management succession is critical to a family business: 30 percent of family businesses survive the transition to the second generation, and only 10 percent survive to the third.

Management succession requires a comprehensive plan for the enterprise, the family, each family member, and other key persons and should address sufficient continuity of the enterprise to maximize asset value, and account for premature and natural death, estate taxes and special family issues.

The component parts of a management succession plan are actually quite varied.

A BUY-SELL AGREEMENT provides for the sale of the stock among the stockholders and the company on the death, disability or retirement of one of the stockholders. Funding may be accomplished by life insurance or periodic payments.

A SUPPLEMENTAL EMPLOYMENT RETIREMENT PLAN (SERP) for a senior family member provides income for life to senior and spouse and a significant liability on the company's books which reduces the value of the company for gifting of senior's stock to next generation. Income on the SERP terminates on the death of the senior and spouse. The SERP is not subject to social security taxes.

A senior family member may sell stock to the company (or next generation) in exchange for a PRIVATE ANNUITY with the payments extinguished at the death of the senior.

A senior family member may sell the stock to the company (or next generation) in exchange for an INSTALLMENT NOTE. Future appreciation in value of the company stock is removed from the senior's estate. The senior is guaranteed a fixed cash flow stream. At senior's death the unpaid balance of the note is subject to estate tax.

A senior family member may sell stock to the company (or next generation) in exchange for an installment note which cancels at death. The unpaid balance on the SELF-CANCELING INSTALLMENT NOTE (SCIN) is extinguished at the death of the senior and not subject to estate tax. The deferred capital gain remaining at death results in income tax liability.

A REVOCABLE TRUST is one that might be changed at any time and an IRREVOCABLE TRUST may not. Assets in a revocable trust remain under the control and part of the estate of the individual who created it. Assets in an irrevocable trust do not remain in the estate for tax purposes.

Under a CREDIT SHELTER (OR BYPASS) TRUST, the surviving spouse receives all of the income and the principal goes to the family upon the death of the surviving spouse.

A QUALIFIED TERMINAL INTEREST PROPERTY TRUST (QTIP) provides income to the surviving spouse for life and allows the spouse who established it to determine the beneficiary upon the death of the surviving spouse. Such trusts are sometimes used in second marriage situations to protect children from a first marriage. No estate taxes are due at the death of the first spouse because the trust uses the unlimited marital deduction.

The proceeds of a life insurance policy are free of income tax. But if the insured is the owner of the policy, the proceeds become part of the estate.

By making an IRREVOCABLE LIFE INSURANCE TRUST, the owner of the policy using the annual gift exclusion to pay policy premiums may insulate the proceeds from federal estate taxes, and the proceeds may be used to pay taxes on the balance of the estate -- often the family business. This permits considerable control over fund distribution, avoids court-supervised administration of the estate, and distributes the proceeds immediately.

An IRREVOCABLE ASSET TRUST permits the transfer of assets to another party -- often children. Gifts, whether or not subject to the annual exclusion, are used to transfer family business assets to the children while deferring loss of control. The trust must provide that the children are entitled to withdraw the money during certain periods.

With a GRANTOR-RETAINED ANNUITY TRUST (GRAT) or a GRANTOR-RETAINED UNI-TRUST (GRUT), the grantor receives the income (or an annuity) for a number of years at which time the family receives the property including any appreciation free from estate and gift taxes. The income distributed by a GRAT is determined at the time of the creation of the trust. A GRUT will provide that the grantor receives a fixed percentage of the fair market value of the property each year. Those worried about appreciation often consider a GRAT and those concerned about inflation a GRUT.

A CHARITABLE LEAD TRUST permits family business owners to provide income to a charity and then transfer the assets to family members. This creates a gift tax charitable deduction at the time of the creation of the trust equal to the present value of the income that the trust will pay to the charity. If the gifted property appreciates, the appreciation is free of estate tax and is passed to the family members.

A CHARITABLE REMAINDER TRUST permits the distribution of income to the family business owner (or family members) and the principal to the charity. Such trusts are particularly useful when appreciated assets are sold because the transaction is tax-free. The proceeds are used to purchase income-producing securities and the donor claims a charitable deduction equal to the present value of the assets.

An EMPLOYEE STOCK OPTION PLAN (ESOP) may enable the owners to sell part or all of the business to employees on a tax-subsidized basis. An ESOP is a tax-qualified plan that is designed to invest primarily in employer securities. The ESOP borrows money to purchase employer's stock. The stock is held in a trust and is used as collateral for the loan. The corporation makes tax deductible cash contributions to the ESOP which uses the cash to pay off the loan.

Under an ESOP, payments to purchase company stock are tax deductible. Tax on payments received by shareholders may be deferred or completely eliminated. Since payments are deductible to the company and tax is deferred to the shareholders, the shareholders may actually receive less by way of proceeds but have the same after-tax proceeds as a taxable sale.

These instruments permit the structure of a management succession plan for almost every conceivable family situation.