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Estate Planning StrategiesThe Closely Held Business
Presented by:
Louis C. Grassi, CPA, CFE – Managing Partner and CEO
Estate Tax Basics
Fair value of married individuals’ estate is subject to estate tax on death of second spouse
Tax rates are: 35% for decedents dying or gifts made after January 1, 2010
and before December 31, 2012
40% for decedents dying or gifts made after December 31, 2012
Estate-Tax Exemption for 2013: $ 5,250,000 for individuals
$10,500,000 for married using full gift splitting
Estate Tax Example
Example – Closely Held Business Owner – Married & owns:FMV House $ 3,000,000
Cash, Stocks, Bonds $ 850,000
Jewelry $ 200,000
Stamp/Coin Collection $ 300,000
FMV Business $ 12,000,000
Traditional IRA’s $ 500,000
Decedent's Life Insurance $ 1,000,000
Total Estate $ 17,850,000
Exemption – combined amount (5,250,000 * 2)
$ 10,500,000
Funeral and Estate Expenses $ 350,000
Taxable Estate is… $ 7,000,000
Assume no planning and if the death of the second spouse occurs immediately after the first, the total taxable estate would be…
Federal Estate Tax due @ 40%
Life Insurance Proceeds
Cash & Securities
Federal Estate Tax shortfall – where is this cash coming from?
Estate Tax Calculation
$ 7,000,000
$ 2,800,000
$ 1,000,000
$ 850,000
$ 950,000
Action Steps:
Transfer residence to a Qualified Personal Residence Trust (QPRT)
Transfer life insurance to a life insurance trust to keep value of death benefit out of the estate
The biggest challenge is the illiquid value tied up in the business asset
Possible Estate Tax Solutions for Personal Assets
Post-Death
Do nothing and be forced to liquidate to settle the estate tax
Take the IRS on as a “Partner” in the closely-held business and pay the estate tax liability over time under IRC Sec. 6166, but this is no easy task and has its own risks best discussed as a separate topic
Sell to a third party to create liquidity
Pre-Death Planning
Purchase more life insurance to fund estate tax
Transfer to the next generation via gift, sale or combination of both
Various Estate Tax Solutions for Business Asset
Purchase Life Insurance to pay estate taxes relating to business value
To avoid estate taxes on Life Insurance the policy must not name the estate as beneficiary AND the deceased must not possess “incidents of ownership” at the time of death.
Create a Life Insurance Trust where the Trust owns the Life Insurance Policy and each beneficiary of the Insured’s estate is a beneficiary of the Life Insurance Trust – they receive yearly gifts from the insured to pay the premiums. Upon death, the life insurance benefit is used to pay estate taxes
The Life Insurance Solution:
Financial Buyer – will want to see several years of clear and consistent financials, with minimal shareholder notes and expenses. Any unusual or extraordinary items should be explained.
Competitor or other Strategic Buyer – probably best to hire a business broker or investment banker to handle process while owner focuses on the continued success of business.
Sale to employees – management buyouts or an employee stock ownership plan (ESOP); allows the business remain close and motivates employees to continue to grow the business because they now have “skin in the game.”
Sale to Third Party Solution:
Gifting Ownership at Discounted Value
Partial sale so next generation has some of their own assets at risk
Retention of Control
Next Generation Considerations
Valuation of closely held business
Gifting Using Discounts
1) Discount for “Lack of Marketability” – stock subject to restrictions like transferability has limited value to a 3rd party investor
2) Discount for “Lack of Control” – less than 51% stock ownership is a minority interest. Lack of control means shareholder has minimal say in important decisions of the business. Therefore, this stock also has limited value to a 3rd party investor.
Recapitalizing Company using Voting and Non-Voting Shares
Parent maintains Voting Interest Shares and retains control of company via voting rights – these shares will reflect a premium value to reflect the control value.
Children are either gifted or sold the Non-Voting Shares, which contain value, but do not enable the child shareholder any decision making powers in the company – these shares will also reflect a discounted value to reflect this lack of control. Hence more company ownership can be transferred because of the inherent discounted value of the non-voting shares.
Retention of Control
Intentionally Defective Grantor Trusts (IDGT) or Irrevocable Deemed Owned Trusts (IDOT)
Irrevocable Grantor Trust is created by parent for each child. These trusts are all “Grantor” trusts for income tax purposes, whereby the income earned by the trust is taxed to the parent – not the trust or the child even though they actually own the shares. This will allow the parent to reduce their taxable estate by paying yearly income taxes on the Grantor trust income. The trust property is not included in the gross estate of the grantor.
A provision can be added to a Grantor trust agreement which would allow the parent to be reimbursed by the trust for any taxes paid, if desired, because of lack of liquid assets to pay tax liability.
Trusts – Grantor Trusts
Grantor Retained Annuity Trusts - GRATS
Betting to Live – used to transfer appreciated assets in exchange for an annuity. GRATs are an irrevocable trust that can pay the grantor a fixed sum each year for life or a specified period in exchange for a initial transfer of another asset, usually an interest in a closely held business. At the end of that period the remaining assets in the trust are distributed to the beneficiaries. If the grantor dies during the term of the GRAT, all the property transferred into the GRAT will revert back to grantor and be part of the grantor’s gross estate. If the Grantor survives the team, hopefully tremendous value of an appreciated asset has been transferred out of the Grantor’s gross estate.
Succession Planning
Key manage-ment leaves be-cause no owner-
ship transfer plan16%
Other2%
Price owner wants is too high
16%
Children not ca-pable of running
business17%
Competent management leaves because of nepotism
9%
No competent successor
management31%
Unaware of possible alter-natives of ownership trans-
fer9%
Most Common Reasons for Ownership Transfer Plans Not Working
Sell to a third party9%
Sell to employees42%
Sell/gift to a fam-ily member(s)
28%
Sell to both family members and
employees 19%
Liquidate2%
Succession Planning
Definitive Ownership Transfer Plans
Employees aren't ready31%
I'm not ready28%
Unsure or un-aware of tech-
niques of transfer29%
In process5%
Other7%
Estate Planning
Ownership Transfer Plan Concerns
Planning for Family Harmony
Giving children grossly unequal shares of the estate
Punishing financially successful children
Forcing children to own property together after your death
Failing to communicate your plan to your children
Tax law is a science, but family harmony is a very personal art. Most clients agree that it’s more important than the things they own.
Pitfalls to Avoid:
Document transactions properly
Don’t punish success
Be fair
Be discreet
Be creative
An Ounce of Prevention:
Planning for Family Harmony
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Explore Options
Buy-Sell Agreements
Sale of shares via promissory notes, to be paid with bonuses or after-tax distributions
Gifting shares
Trusts as shareholders
Keeping the business in the family is often the primary goal of succession planning:
Other Alternatives if keeping the business in the family is not the goal:
Explore Options
Management Buyouts
Sale to employees through an Employee Stock Ownership (ESOP) or cooperative
Sale to outsiders
Liquidation
5
Implementation of Plan
Divorce or remarriage of any primary participant in the plan
Death, disability, retirement or other departure of any stakeholders involved
Substantial change in the profits of the business
Some important events should trigger a visit to the owner’s service professionals for possible revisions to the plan. These include:
Questions?
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