GETTING THE BUSINESS PREPARED FOR TRANSITION – ESTATE AND TAX

CONSIDERATIONSPresented By:

Anthony J. MadoniaAlliance of Merger and Acquisition Advisors

July 23, 2014

233 S. Wacker Drive, Suite 6825

Chicago, IL 60606-1609312-578-9300

312-578-9303 (fax)

ANTHONY J. MADONIA

o Founder and President of Anthony J. Madonia & Associates, Ltd., a law and tax advisory firm located at the Willis Tower, 233 S. Wacker Drive – Suite 6825, Chicago, IL.o Tony is an Attorney and Certified Public Accountant who focuses in the areas of Estate Planning and Administration, All Aspects of Business Planning from Start to Finish, Corporate Law, and Taxation.o Tony has a Bachelor of Arts degree in Accounting from the University of Illinois and a Juris Doctorate from John Marshall Law School. o He teaches Estates & Trusts and Estate Planning & Drafting as an adjunct faculty member at John Marshall Law School. o He is a member of the American Bar Association, the American Association of Attorney-CPAs, and the Justinian Society of Lawyers. o He has served as Chairman of the Asset Protection Committee of the Chicago Bar Association.

TAXES GENERALLY DUE UPON SALE

o Capital Gains Tax:o Excess of the amount realized over the adjusted cost

basiso Federal tax rate of up to 23.8%

o Recapture of depreciation:o Taxed as ordinary income

o Implications:o Liquidity problems as the taxes are due at one time o Can move the seller into a higher tax bracket, further

increasing taxes and reducing the value of deductions

ESTATE AND TAX CONSIDERATIONS

o Transfers of business interests to family memberso Outright giftso Irrevocable trusts for the benefit of childreno Family limited partnerships

o Use of Irrevocable Life Insurance Trusts

o Use of Charitable Remainder Trusts

TRANSFERS OF BUSINESS INTERESTS TO FAMILY MEMBERS

o If one of your goals is to move a portion of the value of the business to future generations, estate planning should be done at an early stage.

o Want to move interests from selling entity for the benefit of future generations when values are low.

o In this way, you can make sure the future generations receive the benefits of the sales proceeds when an asset or stock sale is completed, while keeping that asset outside of your taxable estate.

TRANSFERS OF BUSINESS INTERESTS TO FAMILY MEMBERS

o Lifetime gift tax exclusion of $5.34 million ($10.68 million for a married couple)

o $14,000 annual exclusiono Allows you to give $14,000 ($28,000 for a

married couple) in cash or other assets each year to as many individuals as you choose

o Current economic and political climate does not give certainty to future exclusion or tax rate

o Can make tax free annual gifts of shares of the family business to children

TRANSFERS OF BUSINESS INTERESTS TO FAMILY MEMBERS

o What if you would like to gift more than either the annual or lifetime exclusion?

o Consider valuation discountso Because of less control and liquidity associated

with shares of a closely owned business, these gifts can be valued at a significant discount.

o Thus, even large gifts of shares may be able to fit within the lifetime gift exemption.

TRANSFERS OF BUSINESS INTERESTS TO FAMILY MEMBERS

o Another option is to set up an irrevocable trust for the benefit of your children

o In this way, the shares are not included in the business owner’s estate

o The children are able to take advantage of any appreciation of the shares without gift or estate tax

o Consider an Intentionally Defective Grantor Trust

TRANSFERS OF BUSINESS INTERESTS TO FAMILY MEMBERS

o Intentionally Defective Grantor Trustso The trustmaker forms and gifts assets to an irrevocable trust

that will likely appreciate substantially in the future.o The trustmaker retains powers over the trust and any income

earned by the trust is taxable to the trustmaker rather than the trust or its beneficiaries.

o An intentionally defective trust is one which is defective for income tax purposes so all income is taxed to trustmaker.

o Benefits:o The trustmaker’s estate is significantly minimized for tax

purposes.o The value of the property in the trustmaker’s estate is frozen

and all appreciation will pass to the trust beneficiaries without gift or estate tax

o The trustmaker can retain control over the business.

TRANSFERS OF BUSINESS INTERESTS TO FAMILY MEMBERS

o Family Limited Partnershipso The general partner contributes business interests to the

partnership in exchange for partnership interests.o The general partner then gives all or a portion of their limited

partner interests to their children.o General partner retains control over assets.

o Tax benefits:o Reduces the taxable estate of the general partner. o Limited partners have no right to control and limited liquidity so

the valuation of their shares can be discounted.

o Also has significant asset protection as creditors may not force distributions to limited partners.

IRREVOCABLE LIFE INSURANCE TRUSTS

o Business owners with a large net worth need to be careful about how they structure buy-sell agreements.

o If their taxable estate (including fair market value of business interests) puts them in jeopardy of paying estate taxes, they might not want to purchase departing owner’s interest.

o Instead, an owner could establish an irrevocable life insurance trust to purchase it.

IRREVOCABLE LIFE INSURANCE TRUSTS

o Business owner establishes an ILIT.

o ILIT trustee and other business owners enter into a buy-sell agreement.

o Owner’s ILIT purchases life insurance policies on other owners.

o Owner provides funds for the ILIT trustee to pay premiums by making gifts or loans to ILIT.

o Shareholder agreement provides for buyout by ILIT.

o At owner’s death, ILIT trustee receives proceeds and uses them to purchase the ILIT’s shares of deceased owner’s interest.

IRREVOCABLE LIFE INSURANCE TRUSTS

o Benefits:o Business interest purchased by the ILIT is not included in the

owner’s taxable estate.

o Provisions of ILIT can be drafted to accomplish owner’s objectives.

o Business owner increases his interest in the business by arranging for it to be purchased and owned by an entity he created.

o Upon owner’s death, the ILIT can become the owner of his share of the business, leading to the centralized management of the business interest for his beneficiaries.

CHARITABLE REMAINDER TRUSTS

o How is it used?o Business owner contributes ownership interests to the

charitable remainder trust, which is an irrevocable trust.

o The CRT then sells this interest to a third-party buyer.

o The CRT does not incur capital gains tax on the sale transaction.

o The CRT is left with cash, which it then pays to the owner and the owner’s spouse for life.

o Upon the death of the owner and his spouse, the CRT terminates and pays the remaining balance to charities.

CHARITABLE REMAINDER TRUSTSo Biggest benefits:

o Owner receives a charitable deduction when he transfers assets to the trust.

o When the CRT sells stock or other business interests, no capital gains tax is paid, leaving more money for payout to trust beneficiaries.

o The trust itself is a tax-exempt entity and is not subject to tax.

o The beneficiaries pay tax on the income distributions received from the CRT.

o Interest in the trust is not included in the owner’s estate as it is a life annuity.