PASSING THE Baton - succession planning

California CPA, August, 2001 by Andrew M. Katzenstein, David P. Schwartz

Succession strategies for CPA Forms

You're too young. You're too busy. The estate tax is going to be repealed, so you'll wait.

Perhaps you're a procrastinator, or just downright uncomfortable with even the mention of succession planning as it represents a loss of control, mortality and myriad other issues. Whatever your reason for stalling, or even if you've started your succession plan, this article outlines many succession planning considerations for CPA firms and offers clarity on how to transfer your practice.

Transfer tax consequences, forced liquidation and business failures are among the dismal results of poor succession planning. In fact, failure to plan for a practice's transition usually results in the loss of the practice's entire value to the family. And since most experts agree that a full, permanent repeal of the estate tax under the new legislation is unlikely--there's no time like the present.

CPAs must not only be aware of ordinary succession planning issues that arise, such as saving transfer taxes and ensuring a smooth transition of their business interests, but they also must be well-versed in the rules imposed by California Business and Professions Code Sections 5000 et seq., that address who may own an interest in an accounting practice.

TYPES OF OWNERSHIP

An accounting practice's organizational form may limit who can receive the practice on the owner's death. Accountancy business owners generally hold their practices in the following forms:

Sole Proprietorship

The simplest form of operating a business is a sole proprietorship.

There is only one owner, who holds the business' assets as his or her property. No entity is involved.

Accountancy Partnership

According to Business and Professions Code Sec. 5072, a partnership, other than a limited partnership, may be registered to engage in the practice of public accountancy, provided it meets certain requirements.

Business and Professions Code Sec. 5079 generally provides that a non-licensee may hold an interest in an accountancy firm, provided that such non-licensee holds only a minority interest, both voting and equity, and materially participates in the business of the firm. The Business and Professions Code defines material participation as an activity that is "regular, continuous, and substantial." Otherwise, there is little guidance from the California code, California Board of Accountancy, legislative history and regulations about what constitutes material participation.

For example, will transferring an owner's interest in an accountancy firm to a family member employed by the firm as support staff jeopardize the firm's public accountancy status? Probably not. Neither Business and Professions Code Sec. 5079 nor its regulations limit material participation to accountants.

While Business and Professions Code Sec. 5072 specifically disallows a limited partnership to be registered as an accountancy partnership, Corporations Code Sec. 16101(6)(A) specifically sanctions the use of limited liability accounting partnerships (subject to the provisions of the Business and Professions Code relating to who may be a partner). However, Sec. 16101(6)(A) generally requires that each of the partners be licensed. Thus, a transfer of an interest in a limited liability partnership generally should be made only to a person who is licensed.

Accountancy Corporation

An accountancy corporation is a corporation registered with the CBA, and which has a currently effective certificate of registration from the board pursuant to the Moscone-Knox Professional Corporation Act. Because Business and Professions Code Sec. 5079 applies to professional accountancy corporations (B&PC Sec. 5151), the same limitations on share ownership are imposed on professional accountancy corporations as those on accountancy partnerships (that is, a non-licensee may hold only a minority interest, both voting and equity, and must materially participate in the firm's business).

WHO SUCCEEDS TO THE BUSINESS

A deceased accountant's choices for disposing of his or her practice at death consist of the following: (i) transfer of the business to a family member involved in the business; (ii) transfer (sale) of the business to a co-owner or key employee; or (iii) transfer (sale) of the business to an unrelated third party.

Family Members Involved in the Business

If children or other close family members are engaged in the business, the owner may wish to cause the business to pass to them at death. This is because, in many cases, it maybe difficult for these individuals to find commensurate jobs outside the business, particularly if they are older and have devoted their full professional lives to the business.

Valuation is the issue here, especially if the business is being left to one child, with non-business assets left to other children. Instruction as to how value should be determined should be included in the accountant's will or trust to avoid family arguments.

Consider a formula clause (a multiple of gross/net earnings), or perhaps have the inheriting and non-inheriting children each choose an appraiser, with each appraiser then choosing a third appraiser and have the third appraiser's opinion control. Determine whether value should be adjusted for the inheriting child's "sweat equity"--to credit the child for his or her work efforts, perhaps the value should be adjusted downward by a set percentage (10 percent to 20 percent).