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.   

Why Use Non-Compete Agreements!

Non-compete agreements (NCA) represent a separate agreement. They could be in an employment contract, or as a separate article in a buy and sell agreement. Sometimes they are referred to as Covenants not to complete. “

This is based on the possibility that an employee can do harm to a company upon termination.  They could know sensitive information about the company’s operation, owners and employee’s personal information, special operations, and proprietary information to a competing advantage, along with so much more.

Picture a very long-term employee working side by side with the owners, for many years, and then leaving to work for the owner’s competitor.  Certainly, there can be issues.

No compete agreements (NCA), can be used to retain employees also.   It would be very difficult to change jobs within an industry or profession when the leaving employee is limited to compete in a geographic and specific industry for a period of time.  However, non-compete agreements are hard to enforce, because in many instances the agreement has overreached and is very broad in the definition of industry and geographic coverage.

Continue reading “Why Use Non-Compete Agreements!”

Key group wants to buy your business, but do they have skin in the game?

When considering the transfer of stock to a key employee, or a group of key employees, (referred to Key group), you need to determine how much they want to be involved in the company, and the risk they are willing to take in the future of the company.

In Tier One of the purchase, the key group will purchase stock.  They purchase stock from future salary, financing, or from future cash flow in the form of dividend payouts.

It wouldn’t be uncommon for the owner to want to see the purchasing employee put some skin in the game.  Seeing the employee be committed allows the employer to consider future financial programs to help the employee purchase the balance of the stock under Tier 2 (the selling of the balance of the stock). 

The owner in most cases will look at the bottom line what they want in the end and the financial capabilities of the key employee.  Smaller employees will try to make it easier for the key person to purchase the stock.  Using a bonus plan to help them buy the stock can be a very useful tool for both parties.  The employer gets a tax deduction, while the employee has additional funds to purchase equity in the company.

Using lower valuation for a better cash flow when business is sold Continue reading “Key group wants to buy your business, but do they have skin in the game?”

What If I Want to Recruit a Key Employee?

The objectives of recruiting a key executive from the marketplace are to make your business more profitable, to grow the company and / or to bring talent to your business that does not currently exist. You must design incentive plans that achieve those goals.

You will always be a slave to your business unless you have capable management in place to run the business when you are not there. If you someday hope to sell your business to an outside buyer, you will need to have solid managers in place to get serious consideration from an outside buyer. As is the case with most companies, the management team could someday become your buyers. If you want to transfer your business to your children, you will need key employees in place to assist them with the transition.

In order to attract the right person to your company, you must offer them an incentive plan that rewards them for efforts that increase the value / profitability of your business.

You should pay a key employee for projects that they initiate. This could be an additional six percent or more of their base pay. When this key employee has a positive effect on the rest of the management team, pay them a bonus based upon that influence. This could be 10 – 20 percent of their base.

When hiring for key management, we find that most compensation packages combine base and incentives. Determine the incentive on the company’s growth once that employee joins you. Decide how much you are willing to pay the right employee and then back into that figure.

Continue reading “What If I Want to Recruit a Key Employee?”