Pending Tax Changes May Be Around The Corner 2022!

 

I am currently reviewing some of the pending tax proposals being presented. Again, these are proposals and most of them will change before enacted.  

It occurred to me as I was reviewing the details of the tax proposals, how many changes I have seen over my long planning career.  It made me think of  how many times clients (YOU AND ME) had to  update our plans at our cost.  It is amazing the disregard the government has for the U.S. citizen in making this system easier to work with. I can understand why so many citizens put off planning, or just get tired of updating.  Unfortunately, this is the reality of the tax system and the changing of administrations.  

In 2017 we had a major income tax change which in most cases helped many  citizens lower their taxes.   It was easy to understand and it did what it was suppose to do, stimulated the economy along with increasing  public confidence.  

It also gave estate owners a path to plan to preservation their estates. The tax policy was working very well and our government tax coffers where growing.  

Pending Tax Changes- Again These are only proposals!  

The Green Book 2021  

Sr. Van Hollen (Sensible Taxation and Equity Promotion (STEP) and other plan such as the American Families Plan, and the “For the 99.5% Act (Bernie Sauders)”  

Income Tax Changes 

  • Top income tax rates 37%-39.6% effective January 2022; > $509,300 for married, and $452,700 for single 
  • Restrict tax deferral, “like-kind exchanges” (swaps of real estate that avoid current taxation that a sale would tigger  
  • Capital Gains might double-(sale of stock, investment real estate, etc. ) qualified dividend with incomes over $1million taxed at ordinary rates. This could be triggered for gains after April 28, 2021 

Social Security Taxes 

  • To coordinate the net investment income and self employment taxes, so unlike current law, a company could pay the owner a reasonable salary or guananteed payment, the overage became federal taxable profits, but not defined as payroll taxes.   This was assuming that the salary, and withdrawals were reasonable  compensation .  

The proposal is to tax pass-through business income (e.g. S Corps, limited liability companies, partnership) of high income taxpayers will be subject to either the net investment income tax or the social security taxes.   

Audits from the IRS: $80 BILLION increase over 10 years for IRS for audits.  

Estate and gift tax:  

  • Bernie Sanders proposal (For the 99.5% Act) calls for a return to lower estate and gift tax exemptions as well as significant changes to the rules on GRATs and grantor trusts 
  • Most dramatic:  Biden’s plan is to make the transfers of property by Giftand on assets owned at death (as of January 1, 2022) triggering events for capital gains taxes.  The gain is measured by the date of gift or death fair market value less basis.   
  • Exclusions: transfer at death to a US spouse.  

So there are other potential changes coming down the pike and we’ll have to wait and see.  Here is the bottom line:   

Split Interest Gifts: Grat’s ; watch for developments 

Grantor Trusts:  At Grantor’s death or trust is no longer revocable 

BOTTOM LINE- 

If you are a business owner with wealth in your business and you have not done any planning, it may be a good time to start thinking about a certified appraisal of your business and your holdings.  Also, you might want to start thinking about what your goals would be for passing your estate assets.  It’s to early to tell where the wind will blow and how you will be affected by any change, but it is not too soon to think of what you wish to accomplish in your estate and business planning. 

As I look some of the potential changes, Life Insurance Planning will become more significant in paying for the additional liabilities of passing your estate assets either by gift or death.  

To help you with your planning, I would like to offer to you my newly published Ebook called,”Unlocking Your Business DNA”. In the book I cover strategies I have used with business owners for over 50 years  with powerful strategies to create growth and profits in your business and also create an amazing amount of leisure time. 

To get the book, CLICK AND SUBMIT 
 
OR,  
 
If you with to receive a free business assessment of your business planning, take our ONE MINUTE SCORECARD SURVEY. Literally, it takes one minute to go through. Once submitted I will send you a FREE ASSESSMENT of our findings. We will be able to pin point the strong point and the points that you need to work on to create more business growth and profits.  

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More to come… stay tuned.  

Issues Of A Growing Company

This is a case study about   a company that did not have a buy and sell agreement in place.  The business has grown substantially.  The owners were concerned about the growth of the company, sacrificing larger salaries to invest and grow their business. 

The accountant recognized that there was a problem if there was a termination of a partner, and referred me to his clients to help educate  them on estate and business planning, and also to help them design a buy and sell agreement.   

Scenario:  

Bill and Sam started a very successful manufacturing company.  They produced the assemblies for hard drives. 

They are a C corporation and have scaled tahe business from four full time workers to about 34 employees. Their client base has grown from just a few to a few dozen over the years. 

One Page Issue(s) (With our team we identified these issues)

  1. The business has never been appraised so there is a question of the value of the company and estate.  
  2. Both partners have families and larger personal liabilities than when they started. 
  3. They have invested their earnings into the business and don’t have a retirement plan.
  4. They don’t have a binding buy and sell agreement, nor a method of funding the liability. 
  5. The owners are expecting the exemption credit to lower which will expose them to death taxes.
  6. Neither partner has done any estate planning, other than simple wills. 
  7. Retaining the key person in the firm who has the relationship with the customers, vendors and key contacts. Because he basically runs the company, the owners take a lot of time off.  They are concerned that the competition may try to recruit him.  If lost, it would have a major impact on the company.

Major issues and immediate concerns: 

  1. Potential fire sale of the firm if there is not a “planned design for buyout
  2. Uncertainty and instability for the employees, especially the key people in the firm.
  3. The possibility of the deceased partners family running the business with the surviving partner, leading to inexperienced leadership. 
  4. Lack of liquity to pay the taxes assessed on the value of the business and other administration costs. Without the valuation, it was a best guess estimate, jeopardizing accurate estate planning. 
  5. Business valuation disagreements, especially IRS litigation. 
  6. Lack of market for the business.
  7. The loss of income for the family.
  8. Lending from the banks could be cut off after the death of one of the owners. No  assurances that loans would be immediately available upon an owners termination. A concern that any new loans in the future may have convenants that credit lines would be redeemed upon a partners termination unless there was a valid buy and sell agreement. 
  9. Stress on the business’ cash flow or credit line  as a result of the surviving owner trying to purchase the deceased partner’s share. 
  10. The possibility of losing their key person to a competitor would be a significant loss to the firm.

One Page Solution

The most critical issues to solve now : 

  • Complete a Buy and Sell Agreement with funding/ both life insurance and disability insurance
  • A Certified appraisal to be done
  • Create strategies to keep the key person with the company
  • Start the process of personal estate planning for each partner

 There were other issues, but we all felt the buy and sell agreement was the most important at this point. 

One Page Solutions For Buy and Sell Agreement: 

  • Cross purchase buy and sell agreement funded with cross owned permanent life insurance
  • The insureds were about the same age
  • They were  both in great health
  • Premiums were about equal in cost, and the corporation would bonus the premium to the owners
  • Since the owners willl sell in the future, having the increased stepped up in basis would save taxes, as the partners plan on selling in the future.
  • Also wanted the insurance company to define full disability through the contract definition.

One Page Solution FOR KEY PERSON:  

A CEEP for the key person (Corporate Executive Equity Plan); For Key Person

  • Cash Equity for retirement
  • Tax free death benefit for family
  • Limited contribution by employee-basically paid in full by employer
  • Tax-free income at retirement- Will create about $200,000 tax free for 20 years at 66

There was a vesting schedule designed for the employee for 10 years. If he stayed he would have a much richer benefit than his 401k would provide

  • Non-compete, Non-recruiting  and solicitation of  employees of the firm,  and Non-disclosure agreement to be executed by key person

Estate Planning: 

Currently, working with the attorney on new wills, trusts, and an irrevocable trust for life insurance. There are some other things we are considering with real estate owned outside the state, such as LLC, AND inter vious trusts.

Triggers:  In the agreement we established the major triggers: death, disability, termination, retirement, divorce, bankruptcy.  We decided to use a disability income policy to fund that part of the plan.  We also wanted to have the definition of disability decided by the insurance company. 

As we move forward we are reviewing other issues yearly.  Also, forming the team with the attorney, CPA, and others was instrumental in accomplishing the results.  

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The Challenges Of Developing A Transition Plan For Small Business Owners- Part 1 of 2!

Many small business owners do not have a plan for the transition of their business. A survey taken a few years ago suggested that only 30% of the small business owners had a transition plan. Out of the 30%, only 50% had a plan in writing. Of those plans, there is no way of telling if they were set up correctly, outdated, or even funded, considering the changing of the business status.  

 Options available for business owners for the transition of their business:  

A structured succession plan would enable the business owner to achieve their personal financial goals as its primary function, which would be to create a satisfactory income, and security for their future. 

A second goal would be to maximize the greatest potential value for the business, which would help the owner with their financial needs in the future, such as retirement.  

Another goal would be the long-term growth and the survival of the business to support family members for the future, key employees, or if the owner wishes to remain attached to the business, as a passive owner.  

One of the key issues is to make sure the business owner has control of the process and has defined the timing of any transition in the future.  

For example, if the owner wants to retire in five years, they must make sure they have implemented proper value drivers to maximize the company value.  Some value drivers take longer than others, such as building the next level management key group. This is the group that may wish to purchase the business at some point or run it for the owner.  

By not implementing this strategy early, the owner may be forced to delay the sale of the business until the strategy is developed, consequently jeopardizing their retirement plans.    

If the business is to be sold outright, there needs to be other quality value drivers working for the business owner to maximize the potential sales price.  

Overall, by not having a succession plan, and awareness of what value drivers need to be implemented, the owner risks not achieving the highest potential value for the business while weakening the ability to time and control their transition from the business.   

 Problems of not having a solid transition plan:  

  • Family equity issues 
  • Income and estate tax exposure 
  • Risk not creating the culture of retaining key persons and family members 
  • Uncertainty for people who have a stake in the company (investors, family members, long-term employee, as an example) 

For small privately help businesses, a succession plan is very personal, and cannot be a template program, as every company is unique, and the owners’ situations are very different. 

The key to a successful transition is having a solid plan which has an orderly process and is tax efficient.   

LEARN THE FOUR WHAT IF QUESTIONS EACH BUSINESS OWNER HAS AND HOW TO AVOID THEM BY REQUESTING THE WHITE PAPER:  CHAOS-THE BIG STORY; REPORT #4.  

Selling Your Business To The Younger Generation!

I am old enough to remember the many small businesses in my hometown. There were all types of businesses such as, meat markets, hardware stores, small groceries stores and many specialty stores. Large shopping centers and malls were just starting to appear, as they would be the future home of many of the smaller stores along with the big chain stores.    

FREE OFFER:  Receive my free E-book;  “Unlocking Your Business DNA” to learn the strategies of growing, protecting, and transitioning your business for greater value” CLICK HERE 

It was the fifties and small business was booming. There were many reasons for the business boom, but mainly it was the population of the baby boomers which gave way for opportunities to buy or start a business.   

Now over 60 years later, things are changing. The boomers that started the businesses are now older and would like to retire and sell their businesses.   

Baby boomers own 2.34 million small businesses and employ more than 25 million people (about the population of Texas)i. This represents about 100 million citizens when you consider family members.   

Incomplete Plans 

A recent surveyii shows that 58% of small business owners have not only failed to complete a succession plan, but many haven’t even considered a transition plan. The significance of this figure is the potential catastrophic effect on our economy as the boomers burn out, die, or become too ill to work. Other studies tell us that only 30% of business owners have a succession plan, and 50% of them are incomplete plans.  

The impact of this lack of planning not only affects the consumer, but also employees, family members, partners, independent contractors, part time workers, down the line suppliers, an endless road of dependence on each business.   

Even the younger generation business owners are affected by the closing of these businesses, as the younger business owners have a type of dependence on the success of the boomer’s generation of businesses.   They rely on these established businesses as suppliers, mentors, etc. 

Receive my free E-book;  “Unlocking Your Business DNA” to learn the strategies of growing, protecting, and transitioning your business for greater value” CLICK HERE 

Younger Generations 

Interestingly, many younger generations are not interested in running the family business. They have seen the sacrifices their parents and other family members have made over the years; they don’t want to spend all the time necessary to run the business.   

This generation, beginning with the babies of 1965 and continuing through 1984, is a big problem for Boomers, who are preparing to sell their businesses. The issues are three-fold: numbers, values and choices. 

A major reason for the potential problems for baby boomers is in the pure number of them. From 1945-1964 there were many baby boomers born during that period which stemmed the growth of the economy. However, the next generation is about 23% less in population. This means there are less people in the younger generation to purchase businesses.   

In the next 4-6 years, when the last of the boomers hit 65 years old, almost 5 million fewer people (23%) will be turning 45, and entering their prime business buying years. This shortage of buyers will create the worst imbalance between small business sellers and buyers in history, and it will continue for the next 20 years.iii 

Values 

Boomers have a vastly different work ethic than the Generation X’s. Not that they are lazy, but their values of working, when and why, are very different. Because of these values there are many Generation Xer’s who don’t wish to have the same work schedule their parents had.   

Generation Xers want to define the “work-life balance”.  Their observation of life watching their parents work all the time, didn’t really make sense to them. Consequently, they want to create more of a balance in life.    

Generation X’s, by and large, doesn’t equate material comfort directly with work. Their “balance” is oriented towards separating work and life. Unlike most Boomers, who live to work, the X generation only works to live. Work isn’t their identity, it’s merely the thing that allows them to pay for what they really want and their living standard. 

Many Baby Boomers’ attitude was, “live to work”. Working a 50–60-hour week was part of their business. Based on data, the Xer’s don’t agree with that lifestyle and are not interested in having a business where the cost is many hours of work.  

Planning for the Boomers and Their Business  

Because there is a shrinking number of future purchasers, small business seller’s must take all the necessary steps to prepare their company for an ultimate sale. In most cases they will need help in preparing for the sale of their business.  

There are professionals who can recommend to you how to prepare for the sale or your business, and to help you create the key strategies to implement for a greater potential value.  

Past Problems  

Many of the strategies needed to create value in business need time. You normally can’t wake up one day and decide to sell your business next week and expect to get the highest potential value.  

However, with the right coaching, you can start working on the strategies that can increase the potential value of your company. Even if you are years away from thinking about selling your business, business owners should engage with professionals to start the process of implementing the right value drivers early, with the end game being to increase the potential greatest value of their company.  

Point to be made  

By kicking the “transition of your business can”, down the road, owners are putting themselves in a terrible position. Not only are they not prepared to sell, they don’t have the systems in place that create the potential highest value, but also there may be a limited number of buyers in  the younger generations.  

If you are a business owner interested in discussing the future of your business, we would be happy to have that discussion with you.  

To aid you with the conversation, we have created an assessment tool that it easy to use. It takes about two minutes to complete, and it will give you an idea of your strong and weak points in your business planning. It’s a free tool called the “scorecard”.  Once completed we will send you a free analysis report of your strong and weak points of your business planning. We will also offer a free phone conference to discuss the results with you. Once you submit your scorecard, we will send you an assessment report in approximately 72 hours (about 3 days).  

Receive my free E-book;  “Unlocking Your Business DNA” to learn the strategies of growing, protecting, and transitioning your business for greater value” CLICK HERE 

Business Owners Essential Planning Tools! Part 2!

Good planning can often begin with owners transferring ownership interest to family members, without giving up control of the business. This type of planning sets the stage for the future passing of the baton and can be highly effective.

The long-term plan of business transition can also focus on who can run the business operations once the senior guard leaves the business. Just because a family member has worked in the business, it does not mean they can run the business effectively.

Business Transition And Succession Planning requires many years to develop the right plan. It starts with finding the right employees to train for the job, and the right people to run the business (this includes family succession situations).  

I have found that “Passive Ownership” can be a particularly good possibility for many business owners. They stay in control and slowly give away the duties over time while running the business, but at the same time slowly disengaging from the business. It gives them time to help prepare the junior successor for the job.

The procedure for “Transition Planning” is critical for a long-lasting understanding amongst the family members, both in and out of the business. Without clear communication to the family members, conflict and bad feelings may occur. 

Business Succession Planning  (Click to receive full report and guide; R-1)

  • What would happen to the business if one of the partners died? 
    • Who will buy your interest in the business?
    • Will the company, shareholders, or the heirs keep the right to own the shares. Are the party’s mandated to buy your shares? 
    • Where will the capital to buy the shares come from? 
    • Do you want the deceased shareholders/beneficiaries to have the choice to run the business? 
    • What is the funding mechanism to buy the business? 
    • How is the life insurance structured to help fund the purchase price?
    • Is the same true for a disability? If so, what is the definition of a disability to trigger the sale. Is the disability funded?
    • What are the rules if a partner wants to sell to a 3rd party? 
    • Is there a “put” right; to have the company buy the shares of a disputed share holder? 
    • What are doing concerning incentives to key employees?
    • How are you supporting retirement through the company? 
    • What are you providing in executive compensation to the key people active owners, and officers of the business?

There are many more questions that need to be answered. The elements of your business succession plan will normally be in your business succession agreement and incorporated in the operating or stockholder’s agreement.

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Operating Agreement:  

An agreement which regulates the company and manages the relationships between the members of the company.

Buy-Sell Agreement

An agreement between the business owners to buy and sell interest in the business at a specified price upon a “triggering event”, such as death, disability, divorce, voluntary withdrawal, non-voluntary withdrawal, bankruptcy, and retirement.

This document is important and serves to obtain a fair price for the stockholder and a path for a smooth transition for the parties involved.

Type of Buy and Sell agreements:

  • Cross purchase: This is between stockholders to buy departing stockholder’s shares
  • Redemption agreement:  The entity (business) buys the shares
  • Hybrid/ a combination of above: A “wait and see buy and sell[1]

Provisions in the buy and sell agreement

The sale price of the departing owners’ interest and how it will be paid

  • Installment
  • Sinking fund
  • Cash 
  • Life insurance[2]

Other Methods To Transfer Property:

Although the buy and sell agreement is an effective method to transfer property, other methods, such as ESOPs, compensation plans, and pension plans have a place in funding.

There are other areas and issues in your business planning that need to be addressed at some point and redefined over time.

The valuation of your company should be done by a qualified and certified appraiser. Business owners seem to think they know the value of their business, however, in more cases than not, they are incorrect.

Having A Team Of Financial Experts Will Help You Plan Your Business And Your Estate.

My suggestion is to create a team of advisors who can meet periodically and report on the status of the business to the “team”.

I have found this to be a valuable tool as everyone gets on the same page in the planning process and understands what the owner wishes to accomplish. 

Over the years I have created the team consisting of the CPA, attorney, banker, investment, insurance and other professionals who come together and review what the status of the planning is up to that point for the business owner. Normally, the team consists of the professionals who have a relationship with the business owner and are currently doing planning for them. Unfortunately, each professional has their own agenda, and rarely knows what the other professional are doing for the business owner.,

In most cases this is the first time the advisors have communicated with each other. I have always thought this was in the best interest of the business owner and was prudent to use these resources. Putting the business owners’ advisors in the same room once a year could be the best planning strategy, they can employ. 

The Bottom-Line Thought

The solutions and strategies are in abundance to solve the issues. The problem is defining what the owner wants in their plan.

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[1] A combination of the redemption and the cross purchase. Usually, the stockholder or trust owns the life insurance on the partners.  Normally driven by tax issues and positioning.   

[2] Life insurance is normally the least expensive way of funding the death benefit when compared to alternatives. The life insurance can also play a role in providing funds to help stockholders purchase interest in the company. 

Compensation of Business Owners! The Good And The Bad!

Owners of small private companies normally receive income as a salary, rather than dividends, and capital gain on the sale of their stock. They also receive other compensatory benefits. In many cases, the business owners can receive rental income from property and assets leased to the company and owned personally (either outright or in trust) by the business owner.  

Because of the tax structure of the company, business owners often find it more tax effective to pay the compensation, rent, royalties from their company to the owner, at the high end of the scale, rather than the low side (common in C Corps).  

A Detriment to The Owner When There Is an Exit 

Receiving this higher scaled income and rental, may have some advantages for tax purposes, and the creation of wealth.  

Having the tax advantages for the business owner, may be a detriment to the selling price during exit planning. This is because the rents and compensation paid to the owner on the higher side lowers the net income of the business.  

When rental and salary compensation are paid on the elevated level, they affect the net income/or net operating cash flow, which creates a downward impact on the selling price! 

At the Time of Exit Transition 

The owner must justify the payout of rental income, compensation, royalties, and other compensatory income. They need to justify the overpayment of this compensation. In a way, the owner must back track the justification of paying the enhanced payouts in the stated areas of compensation. This may put the owner in a position of receiving nondeductible “constructive dividends” paid by the company, resulting in a retroactive tax liability.  

Minority shareholders of the company could complain that the enhanced payments to the owner’s transgression of overpayments is a breach of a fiduciary duty owned to them. Since the over self-generous payouts to themself, there is an effect on the stock value. Consequently, minority stockholders are going to be affected by depressed value. This concerns stock bonus to minority stockholders and key persons.  

One of the solutions to this issue is to start to shift part of the enhanced payouts to more of a mid-level range of the fair market value. This will allow you to enhance the net income/net operating income for the company.  

Along with enhancing the net income and net operating income for the company the shifting of revenue to middle-management, will build a stronger management team.  

Three Key Value Drivers  and Why Do They Matter? 

Value drivers are the elements of a business (systems and procedures), which create business value.   This post will cover  Next Level Management (NLM).  In part 2, I will cover  diversified client base  and  operational systems.  

Although there are nine transferrable value drivers, I am going to concentrate of three of them. Although all the value drivers are important, the three I will discuss are considered key drivers.  

The three value drivers are key in creating appeal to prospective purchasers of the business. They are important drivers, and at the very least, drivers’ businesses must have in order to grow.   

When a new business owner asks me when they should be thinking  about their future exit of their business, my answer always is, “the day theystarted their business is the time to start planning for an exit.”     

As you will see, the value drivers in most cases  need time to develop.  As we go through the three of them, you will see that they are strategies that can be implemented at once, but in many cases, need time to develop.    

Next Level Management (NLM):  Successful businesses with value, require business owners to delegate responsibilities to the management team.  NLM is particularly important because without a good management team, it would be hard to implement the other value drivers which are needed to create the maximum business potential value.i    

Finding and developing a  NLM  team is a challenge for many business owners. However, once the NLM is created, they usually become the team responsible to make the difference between where the business is now, and where the business would like to be.   The NLM is the key to  implementing the value drivers and the operation of them.   

Roadblocks for Business Owners in Developing Their Next Level Management

Many owners believe only they can keep and control the company’s success, since they built the business from infancy.   They  struggle  giving up even small types of control. The thought of not being involved in some of the daily business decisions, scares the daylights out of them, nor do they like the loss of control.    

Lack of installing the value drivers over time.   

 They spend their time working in the business as opposed to working on the business.   I call it their “Business DNA.”    Change is scary and thinking that someone else would be running the business is not consistent with their  fundamental  beliefs.  The possibility of someone else making decisions, which could build or ruin their business is too much for them to imagine.   

Fear of change.    Even if a business owner is not thinking in terms of an exit plan, they do like to think of creating business value. Once they are educated as to how value drivers affect the future value of their company, they become more open to  creating the value drivers, and making the changes.    

Misconception of owners:   Benefits derived to the business owners by installing value drivers is the result of the “full potential value of the business.”   The business grows as the business owner does less work, since the work has been handed off to the NLM.     However, owners have the common concern that installing value drivers will take too much of their time.  With proper planning, implementing the value drivers will create a more stable business, create better performance and scalability.   It is important that the owner understand the concept of developing the NLM team, so that team can create, implement, and manage  the value drivers, as opposed to the owner.     

It is possible for the owner to create the NLM where the owners have some control, and still can play a key role in the company.  Their leading role would be to delegate more responsibilities to the NLM, while focusing on other business responsibilities.    

 Many owners continue to do tasks they despise, just to keep a perceived control.  In many cases, the owner needs to take small steps in giving up control before they can start to feel more comfortable.  This is understandable since these are the things, they did to grow their business from day one of the business.     

The owner will see more growth in their company by implementing the value drivers, which will create more options for them when a future transition is a being considered.   

In my book, “Unlocking Your  Business  DNA,” I  discuss the problems business owners have working on their business as opposed to time spent working in it.  One of the factors missing is the value of creating value drivers for their business growth.   Once they realize value drivers create increasing company value, they get on board for future changes.  

 Through our discussions with business owners, we need to express to them that most future buyers will not want to buy the owner.   They want systems, management, and growth ability.       

Many owners think that they need to be involved with all the problems and issues of their company, thinking they have all the answers and the solutions.   Although this makes the owner feel in control and gives them  self-worth, it does absolutely nothing for the future value of the company, and in some cases may decrease the value.   

Success In Business Is Not Without Challenges!

DEFINITION OF BUSINESS GROWTH AND TRANSITION 

I often refer to my business planning as “Business Growth and Transition,” because I consider the business and the owner, as two separate and distinctive entities.  

For example, when the business is growing, the owner of the business needs to grow with the business and envision needed growth. As a business owner, he/she needs to continue to learn, ask more questions, depend on their instincts, experiment, be willing to fail, along with many other experiences to create the changes neededWithout the business owners’ creativity and involvement, the business will stop growing.  

Likewise, when planning for the business entity, we also plan for the owner personal needs. The business success creates personal challenges for the business owner, such as succession, estate taxes, family distribution, protection of the assets, and a host of financial and personal planning areas.  

STAGES OF A BUSINESS 

The business has two distinct stages it goes through which are critical; I define them as survival period and growth period 

Survival period is just what it means! Staying alive! This is where owner learns how to maneuver through the maze of “business savvy” strategies. “What doesn’t kill you, will make you stronger.” 

The survival period of business consists of: 

  • Excessive amount of time, sweat, and patience, luck, and much more.  
  • Bottom line:   Survive staying in business.  
  • Cash flow, Capital improvements, Inventory, client development create many challenges. 

The Growth Mode: 

 Not to simplify, but this is where the action is. It is up, up, and awayWhat needs to be done during this stage:  

  • Creates the opportunity for the future value of the business.  
  • To expand in all areas of the business. 
  • Inventing yourself and the company if needed, this includes building value drivers and transferable values. 
  • To become creative, reinventing of products, customers, process. 
  • To reinvent your markets and your clients. 
  • To build a customer base with loyalty, creating culture, and next level management. 
  • Much More… 

The expansion in Growth, (NOT ONLY) in markets and products, but also employees and the culture of the business. This is extremely important for the future of the business value, with the focus on growing your business value and to create transferrable value for the future. Owners need to start the process of giving up some of the control to middle management. This also means creating strategies which allow the owners to walk away and allow the business to run effectively and efficiently normally. This is my “Can you Take three months off” question, without an impact on your business profits?   

Disadvantages of Growth/ and letting Go 

You are giving up control to your management team! You are giving up things you controlled from the very infancy of the business. This is good because a future purchaser wants to buy your business as a running entity. They want a business that can run, and without YOU!  

When you start to delegate to others, things can happen. Your key people will learn how to run your business, and start thinking like an employer. They will develop greater relationships with your customers, advisors, and vendors. They will start to create profits for you, ease your time in the business, and allow you to enjoy more free time, however, there could be a price to pay!  

Tough Questions to Ask 

  1. What if your key people got to know your business so well, and they wanted to buy it from you, what would you do 
  1. What if you did not want to sell it to them at the time they want to buy? Will they walkWill they stay? Will the relationship change?  
  1. Will they go to a competitor 
  1. Will they take your customers and employees with them 

If this happened, what are you doing to protect yourself 

Consider this:  I recently had a client who went through this nightmare. The key people (2 key employees), left and started their own business. They also took other employees and customers with them.  

Unfortunately, the protection which we outlined to the owner three years prior was never implemented, and they are paying the price for it now.  

We told them to make sure they had programs in place to protect themselves from the business growth and success. 

Things Such As:   

  • Key person documents:  such as non-compete, non-disclosure and non-solicitation of customer and employee agreements.  
  • Benefits with Vesting:  We also suggested that they put in a vested benefit package for them and stagger the time where they would only have a partial vesting immediately  (we have found this to be a valuable motive to stay).  

Lesson to be learnedIf it happened to them, it could happen to you. Your key people will take over your business, which is good because as it creates transferrable value for the future. However, you must protect yourself from your business success.  

BEWARE FINANCIAL ADVISORS: THIS IS AN EASY TAX TRAP YOUR CLIENT COULD MAKE! LEARN A FEW EXEMPTIONS AND YOU WILL STAY OUT OF TROUBLE!

 Recently, we worked on a case which involved an endorsement split dollar plani, where the split dollar agreement involving the trustee   of an irrevocable trust was terminated pursuant to a “rollout. The agreement was between the employer and the trustee (endorsement split dollar). The result would have been a “transfer of value,” in which the death benefit exceeding the consideration would have been taxable income.  

If the split dollar plan were a collateral assignment split dollar, there would not have been a  “ taxable event”, as the sale of the policy would have been made to an exempt party, the insured, (grantor and the insured are one in the same).  Under the endorsement Split dollar, the company was selling to the trustee, not an exemption entity.  

Transfer for value jeopardizes the income tax-free payment of the insurance proceeds. Under the transfer value rule, if a policy is sold for consideration, the death proceeds will be taxable as ordinary income, more than the net premium contribution.  

Besides the outright sale of the policy, there can also be a taxable event if the owner is paid in consideration to change the beneficiary. This would be a transfer of value; thus, the death benefit is taxable beyond the consideration paid for the policy. The consideration paid to change the beneficiary can be any amount.  

Consideration does not have to be money, it could be in exchange for a policy, or a promise to perform some act or service. However, the mere pledging or assignment of a policy as collateral security is not a transfer for value.  

Transfer for Value Exceptions:   

  1. Transfer to the insured 
  1. Transfers to a partner of the insured 
  1. Transfer to a partnership in which the insured is a partner 
  1. Transfer to a corporation in which the insured is a stockholder or officer (but there is no exception for transfer to a co-stockholder.  
  1. Transfer between corporation in a tax-free reorganization if certain considerations exit.  

A bona fide gift:  is not considered to be a transfer for value, and later payment of the death proceeds to the donee will be paid income tax-free.   

Part sale and gift transfer actions are also  protected under the so-called “transferor’s basis exception”  which  provides that the transfer for value rule does not apply where the transferee’s basis in the policy is determined  whole or in part by reference to its basis in the hands of the transferor.   

Another transfer for value trap can occur in the situation when you have a “trusteed cross purchase buy and sell agreement”, to avoid a problem of multiple policies when there are more than just two or three stockholders. When the trustee is both owner and beneficiary of just one policy on each of the stockholders, a transfer for value may occur when one of the stockholders dies and the surviving stockholders then receive a greater proportional interest in the outstanding policies which continue to insure the survivors. This can be remedied by either using an Entity Redemption where the Corporation purchases the interest of the deceased stockholder’s interest.  

This can also cause exposure of transfer of value when transferring existing life insurance policies, insuring stockholders to the trustee of a trusteed cross purchase agreement, which does not fall within one of the exceptions to the transfer of value rules.  To avoid this initial ownership problem, the trustee should be the original applicant, owner and beneficiary of the polices.   

Without A Conclusive Direction, We Know This Case Will Go Bad for The Family!

Re:  Limited Information Case!

Current fact-pattern (albeit scarce)

This was a case which a professional advisor brought to us. We did not engage this client because there was a lack of facts collected. However, we did want to demonstrate to the advisor, that there were options his client could consider if there were more accurate facts.[1]  As a professional advisor you must obtain many accurate facts of the current situations.  This was a case which had great potential; however, the client was not willing to put the work needed to find solutions.  

Dad is planning on leaving family business to son A, with son B to inherit other assets.  Dad is hell-bent on leaving business at death to get the stepped-up basis. Which is fine if you know all the facts, but he didn’t know all the facts, nor did his advisor council him on them.  

There is no certified appraisal of the business, worth $10,000,000(owner suggested). Spouse would inherit other property (rental real estate and residence along with stock portfolio about $5,000,000). There are no mortgages on the commercial real estate or the residence. 

  1. There is no certified appraisal of the business. 
  2. No estimate of real estate value. 
  3. Dad’s health is questionable. 
  4. No life insurance or corporate benefits other than health insurance.
  5. Estate documents are very old- 25 years old. 
  6. Accountant was not proactive in the planning.
  7. Advisor did some investing for the estate owner.

MODELING:  Until we had more facts about the client’s situation we are limited in our models. However, there are some hypotheticals as options.  As mentioned, the options available need more facts before for these can be considerations. 

  1. Do a current certified appraisal. The cost to litigate in Federal Tax Court compared to a certified appraisal is dramatic. 
  2. Recapitalization of company, creating non-voting stock to create a minority discount, and to use the gift tax exemption to gift this stock to his son maximized before 2026 the gift tax exemption and estate exemption ends.  
  3. Family trust for income purposes for the spouse with son B as beneficiary.  (stepped up basis, and unified credit available)
  4. If exemption credit were less at dad’s death after 2026, use marital deduction and continue gifting program.  
  5. There is also the possibility that Dad could gift limited shares to Son A and then also sell the other shares to Son A with a SCIN[2]. Self-Cancelling Installment note based on his health this could be a consideration.
  6. If company was a pass-through company, spouse could enjoy income from the company after dad’s death without employment.   
  7. Suggested using the company to create tax-effective benefits for the family members, such as a Cash Balance AccountExecutive Compensation such as Deferred Compensation.  
  8. Family could set up an irrevocable trust funding it with a second to die life insurance policy and gift the premiums to the trust.   The tax-free life insurance death benefits could clear up any liabilities, taxes, or level more of the estate value to the sons. 

Keep in mind, this is a hypothetical model, and there are many more directions which we could go.  It is extremely important that the professional advisor get as much information they can from the clients, and their other advisors, so there is a correct representation of the current situation.   In this way, you can build the models needed to satisfy the clients financial wishes.  


[1] DISCLAIMER:  we did not engage this client. Lack of facts.

[2] This is a method of transferring property when the mortality of the owner is questionable because of health issures. There is a premium that must be paid on the sale.  If the owner lives longer than mortality, the family will end up paying more.  However, if death occurred less than mortality, the note would be cancelled.  (owner must not be terminal ill when they enter this transaction.)