The Small Issues Which Business Owners Need To Know About!
When working with business owners, it is important to communicate many of the overlooked issues which may blindside them and cause disaster in their financial future.
Small issues turn into major problems bringing with them costly consequences. Many of them are obvious, and can be game changers in your future.
Whether you are an advisor or a business owner, some of the ideas I put forth will help you communicate these overlooked issues.
I am sure if you asked 10 people to describe what estate planning is in one sentence, you would get 10 different answers.
At one time most advisors and business owners would suggest that estate planning is about reducing taxes. However, I would disagree that estate planning is just about paying death taxes and mitigating estate costs.
To me, estate planning consists of three phases, creation, preservation, and distribution. Each of the phases is distinct in and of themselves.
Creation is the concept of money, and accumulating. Implementing strategies, which allow estate owners to create wealth, and avoid losing wealth by making financial mistakes.
Preservation is about protecting what you have from, inflation, lawsuits, expenses, and taxes.
Distribution is the orderly distribution to your heirs. It also is a phase where the estate owner can distribute wealth to certain beneficiaries, at the least cost possible.
DORIS DAY: THE EXAMPLE
Doris Day’s husband died in his 60’s. He had taken care of all the financial areas of their life. After his death, Doris Day did not know what she had, or what she owed. The net result was she ended up owing a fortune to the IRS, in income and estate taxes.
Business owners not only have needs as business owners, but also have needs as individuals. Consequently, it’s not only the business planning that needs attention, but also a coordination of their personal situation. In many situations, the owner’s planning is more complex because of the business ownership.
Questions which need to be asked!
When I ask them, what estate planning they have done to date? In many instances, to them it means, “do I have a will”? Or,
- How often do you discuss estate planning with your spouse?
The Doris Day story starts to make sense to them. In many cases, they haven’t discussed any of the specifics of the estate. Because of that, the estate looks like this funnel. Without the planning and specific issues remedied, the distribution through the estate funnel will be very expensive, with much wealth being wasted due to unnecessary costs and taxes.
- Do you have an estate equalization plan for your children? Especially when there are children from a previous marriage .
Successful business owners never seem to die at the beginning of something; they never seem to die at the end of something; rather they all seem to die smack bang in the middle of something.
Do they ever die at the perfect time?
Because of not dying at the “right time”, most business owners’ estates have a siphon of taxes, fees and debts. There is a major difference between their gross estate and net estate.
They have wealth going into the estate settlement, but pennies coming out.
Nothing is coordinated. The will reads one way, but the assets are titled very differently. There are no plans to fund the estate liabilities, so assets need to be sold. In many cases, assets sold for pennies on the dollar. In many cases the best estate assets are liquidated first, leaving the heirs with non-preforming assets. .
When I ask business owners what their worth is, I normally will get an answer of value. My next question is, “is that gross or net”?
That statement is profound. Most business owners don’t think about the net results of their estate, especially, when they haven’t done proper planning. They don’t realize they have a partner in the federal and state government!
Is it fair that a “lifetime of effort” is lost at a business owner’s death? However, business owners have a choice to eliminate the estate costs. It is a voluntary tax. However, many owners don’t take the time needed to learn how they can eliminate the largest taxes they will ever pay. Many don’t even know they have these options.
I am amazed to see so many business owners who have large estates not funded with life insurance. Life insurance is 2% of capital and the least expensive way of paying a known liability. It amazes me because business owners have advisors such as financial, lawyers, accountants. Somehow, they are not getting the advice, or if they are receiving advice, they are not taking it.
The Four Corners Of The Financial Square
Credit, cash flow, taxation, inflation…
Credit: This is the lifeblood of today’s economy. When business owner wants to set up a new business, expand, or purchase property, they need cash. Usually cash is not available. They need the lending institution for the funds;
Cash flow: To obtain the line of credit, the business owner must present to the lending institution with a stack of cash flow projections to justify the plan to repay the debt.
Taxation: The government assists in the lending exercise in that interest is deductible to the business.
Inflation: This is a two-edged sword. In times of inflation, assets capital growth is enhanced. When long-term debt repayment is assisted in inflation times: (the fixed price is lower over time).
When company borrows money
When a business owner borrows money, they end up signing twice. They sign for the corporation, and they sign as a personal guarantee.
Corporation assets are at risk.
As a personal guarantee, personal assets are now at risk.
Consequently, the lending institution is now the first heir in line for estate assets. The lender becomes the “first heir to the estate”
As a philosophy, “the debt should last no longer than the person who created it”
Two signatures on the debt: Company assets at risk, and personal assets.
The debt is secured by property; corporation and personal assets are at risk.
- What would be the maximum amount of corporate liabilities in your business at any one time?
- Have you, your spouse, or your partners had to back these liabilities with personal guarantee and collateral security?
- What happens to these guarantees in the event of owner’s death?
If the bank gave you money and told you that for 2%, your debt would be wiped out at your death, and
- no other payments would be needed no matter what the outstanding balance is. Would you grab that deal?
Four Ways To Pay Estate Taxes:
Another debt would be the estate tax liabilities such as the taxes on the federal and state level, along with other estate transfer cost. Options to pay these liabilities;
Cash: Loss of capital and the income of the that capital; for example, over 10 years, at 4%, the estate would lose principal and opportunity of that money. Also, using cash from the estate lessens the opportunity to purchase valued assets in the future.
Sell the assets: Example: The estate has a property valued at $1,000,000, with a growth of 8%. This is the asset to be sold first. The problem you are “LEAVING THE WORST ASSETS IN THE ESTATE” going to your heirs. You just sold the best asset in the estate. Also, this assumes you can sell the asset (cost of the sales). In many cases, even good assets sit on the market for a long time, while the estate liability keeps incurring penalties for non-payment. However, look at the future opportunity cost the estate just lost. At 8% growth, the asset would have doubled in just over eight years. Very costly.
Borrow from the bank: You pay back the bank. Principal and interest is no longer available to be invested until the loan is paid off. What is that costs? In essence, the business owner’s estate just mortgaged the heir’s future. They could have funded the liability for 2% of capital cost, and not 100%+ interest cost. Again, will the banker give you the money? Consider the big kahuna just died, what assurance does the bank have to make sure the debt can be paid back.
NOTE: all the above solutions are expensive, and assume they are available to the estate. In most cases, they will not be available.
The last option;
PRE-PAYMENT OPTION: Using LIFE INSURANCE 2%
Methods; a, b, c, cost BETWEEN 100%- 114%. The prepayment option costs anywhere from 1.5% to 2.5% total cost. Plus, the Pre-payment options eliminates the remaining payments of the liability.
- In the event of your death would you want your estate to repay the outstanding debt of $1,000,000. How would that happen?
This is a loaded question. Simple, but thought provoking! It’s are job to make sure the business owner has been exposed to the simple issues which may be significant if not taken care of.
THE TOPIC OF DEATH
In conclusion, let me say that it is up to you and me to introduce the topic of death into the economic equation of a business owner’s life. These are hard questions; questions that people may not like to deal with at the time, but will eventually appreciate the fact that we had the courage to raise them.
If you are a business owner, these are the questions you need to ask yourself and share with your family, discuss and seek counseling concerning them.