Introduction
As professional planners, one of the most important services we can do for business owners, is to communicate to them the importance of the planning of their personal and business assets in a coordinated effort. My experienced is that business owners are so focused on running their businesses, they tend to neglect many parts of their personal financial objectives. When you break it down, they have the same financial problems as individuals with the additional and complex areas of business transition and succession. The purpose of this white paper is to discuss the various elements of their financial planning and highlight some of the critical areas. “Key Essentials Elements” are financial areas which cannot be neglected. If the key essentials are neglected, owners are destined to financial failure, no matter how hard they work in their business, they will have a financial failure, with few exceptions.
Many laws come out of Washington, which are relentless and never ending. There is no mercy for the taxpayer as the game keeps changing from one administration to another. Most tax policies change over time as new administrations are voted in. Consequently, taxpayers are always planning to maneuver around the tax changes to help avoid a financial disaster.
A perfect example is the current estate and gift tax exemption which will sunset in 2025. This will require more extensive planning, even though taxpayers have updated their estates and paid huge fees, when the exemptions were changed some years ago. The reality is laws change all the time and taxpayers can either change with them or do nothing and face the consequences, leading to financial conundrum.
A well-designed estate plan will consist of both the estate and business planning. The business plan would not only consider business growth and distribution, but also, the ultimate transition and succession of the business, due to an event such as your death, disability, or retirement.
Basic Planning documents:
Power of Attorney, Health Care Proxy, Disposition of Remains Appointment (DORA), and Will.
The use of a Revocable Living Trust (RLT) can be used, as opposed to a Will, for estate disposition. The RLT is a valuable tool. Assets are transferred into the trust and titled in the name of the trust. The Grantor creates the trust, and is normally a co-trustee, keeping asset control. The trust creates successive trustees to manage the assets in the event of your incapacity.
A Limited Liability Company is an additional tool which may be used, in the context of your business.
Advanced Directives Business Powers of Attorney:
These documents deal with the unexpected disability, illness, or incapacity. It only makes sense that you should have these documents in place since the odds are great that you could have a long-term disability before age 65, and the odds only increase after that age.
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Power of attorney (POA):
This document names an agent(s) to manage financial affairs if one becomes incapacitated. Fiduciaries act on your behalf. They are called an “Attorney in-Fact”, and they manage financial decisions and transact business on your behalf. It is possible to have two separate power of attorney documents. One for your business, and one for your personal property. You can also appoint different people for each POA document. This makes sense because your personal representative may not have the business sense and experience to deal with some of the tasks needed when dealing with your busines affairs.
The POA can be effective all the time or can be effective only under certain situations. This is called a “Springing Power of Attorney”. An example of this is when the POA only springs into effectiveness when a doctor signs off on your incapacity to deal with your affairs. The person in that role should be aware of this.
The purpose of the POA is to avoid costly and complicated court appointed guardians which is the procedure when there is no POA, and when someone is considered incapacitated. Since it is in place when executed, there is no delay upon the incapacity of an individual.
Health care Proxy (HCP)/ also referred to Living Will.
This appoints someone to make health care decisions if you are unable to do so yourself. Disposition of Remains Appointment (DORA): Provides a way to appoint, in writing, someone who shall control one’s final arrangements.
WILL:
The Will is to provide instructions on how your assets are to be distributed amongst your beneficiaries. A Will does the following:
- Outlines your distribution wishes- specific gifts of tangible personal property
- How your business is to be continued or distributed
- Names executive(trix) or personal representative responsible for probate accounting and filing, tax liabilities and the payment of them, and the disposition of the balance of your assets
- Appoints guardianships
- Establishes trusts to protect assets
The Will specifies instructions regarding your intentions of the business; sold, liquidated, continue. If your intention is to continue the business, your Will has instructions to do so. It would refer to any operating or buy-sell agreement if they exist.
Through your Will you can establish a Testamentary Trust that will direct that your assets are managed and distributed based on your specific wishes. Assets can be managed for family members and distributed at the times you specify.
For example, if you wanted certain property to go to certain members of your family, you can direct that. You can also preserve the principal of your assets for your children should your spouse remarry.
Revocable Living Trust (RLT)
A RLT can control your assets during your life and after your death. Once a RLT is set up you would transfer the title of your assets (stocks, bonds, real estate, life insurance, etc.) to the trust. You would then become of the trustee of the trust. This gives you complete control of the trust assets, and the trust. The RLT is not irrevocable until your death. You can change it anytime or collapse it if you wish. Property is not tied up in the trust, as you can change the title back to yourself in the future.
At your death, there are no assets in your name, so, no probate. The successor trustee will gain control of your assets to distribute them according to your exact instructions. At your death assets will go directly to your heirs. No probate, so, lower estate administration costs, and no court delay in distributing your assets to your heirs.
Along with the issue of distribution, the trustee will ensure continuity of assets management during a period of incapacity.
Limited Liability Company.
There are several advantages to using an LLC in the context of estate planning.
- Enables you to preserve significant control and management while reducing your estate costs
- Ability to transfer assets to family members, tax efficiently
- Can create significant valuation discounts using limited liability interests
- More income tax savings compared to estates and the double taxation of a C corporation
- No limit of number of shareholders
- No limit on the types of entities the interest of the LLC can hold
Business Succession Planning
The challenge of a business transition upon the death, disability, or retirement of the owner(s), is will the business survive? This requires long term constant planning. Admittedly, transition planning is one of the of the most complex challenges in business and estate planning.
Objectives:
- Income for business owner’s retirement
- Maximum but fair price for share of business
- Smooth Transition
- Could include compensation for family members in and out of the business
Major Challenges
- Retirement for owners/income
- Reduction and payment of estate/State taxes
- Creating liquidity for the transition and new ownership
- Creating a formal business succession plan
- Family ownership and non-family ownership needs, communicated
To be continued in Part 2
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