Keyman Insurance: A Critical Component to Your Business

Keyman Insurance: A Critical Component to Your Business

A critical component to successful planning includes identifying the key employees of a business. A key employee is an employee or executive who is essential to the company’s operation and profitability.

Key employees can be critical salespeople, those with specialized skills such as engineers; an executive; an owner; or someone that develops intellectual property. There is no legal definition of who qualifies as a key employee.

If this employee would happen to leave the business, it could prove disastrous for the organization. The costs that a company can incur upon the loss of a key employee are high and range from the expense of hiring and training a replacement to the loss of sales connected to the loss of a key salesperson.

For this reason, companies should purchase a keyman insurance policy that will safeguard them against these losses. Ideally, keyman insurance is about protecting your business from the sudden loss of a key person. 

Keyman insurance can also be used in such a way to provide value, security, and incentives for key performers. It can be used to attract and retain employees and provide protection for the key employee’s family in death or disability.

Golden Handcuffs

This is sometimes referred to as golden handcuffs or a retention bonus if you offer them ownership of the policy and the policy’s cash value after they have been with the company for a specific time.   

This can be done through a restricted endorsement.  The transfer of policy ownership to your key person is currently exempt from taxation under the IRS transfer rules.  This is a flexible option, so rather than having the key person’s ownership “vest” after 10 years, you should have it vest in one-year increments on an annual basis to keep the incentive building.

If the policy vests to your key employee, the premiums can become tax-deductible for your business, and before vesting, while your business owns the policy, you can access the cash value for your business operations for all the other reasons discussed above.

A keyman insurance policy creates a private financing source for the business

Creating private financing so the company’s money never quits working

How would you like to have several dividend-paying, high cash-value life insurance policies building concurrently, providing your business with death benefit protection against the loss of key employees,  and building a private financing source with tax advantage growth?  A keyman insurance policy creates a private financing source for the business much, like a BOLI policy and an Banking Policy

Better than a Bonus

Bonuses are great. But do you want to pay a big bonus to a critical employee to have him or her leave you for a competitor? 

Better for Them-They do not need to wait until retirement

Many of the ways companies reward and retain valued employees is focused way too far into the future. Pension and retirement plans will not pay anything until retirement. Let us not forget the regulations, administrative headaches, costs, and the volatility of retirement plans.

Bottom Line

If you have someone critical to your business, it would be a wise idea to get some insurance on them to protect both you and your business.

 

A Few Tax Rules Used By The Wealthy

A Few Tax Rules Used By The Wealthy

 

The rich play by different rules than we do

 

Not because the tax rules don’t apply to them, but because they take the time to learn more. Tax law is constantly changing and is difficult. Those that do not spend time learning  about their tax situation and actively work with their tax professional to reduce taxes, will pay more taxes. 

 

Tax planning is an on-going activity and you should be meeting with your tax professional at least once a year. This is not something you should expect to have done for free. Good tax planners work diligently to keep up with changing tax laws. They deserve to get paid.

 

Below are some advanced ways to save on taxes

 

As the number of moving parts in your financial world increase, and the more flows of income you have, the more important tax planning becomes. 

 

In order to utilize the tax law, you have to do tax planning services. Taxes are most likely the biggest expense in your life.

 

Cash-Flow Planning and Tax Planning can create much bigger returns than what you are getting in your 401 (K), IRAs, and other investments 

 

These strategies are for informational purposes only. Do not take any of this as financial or tax advice. Some of these strategies may apply to your specific situation and some may not. Consult your tax professional to see if any of these strategies apply to your specific situation.    

 

If you enjoy over-paying on taxes, there is no reason to do tax-planning. If you don’t enjoy giving the government money call us today we will help you stop giving your money away. 

 

  • Life Insurance
    • The wealthy not only use life insurance to pass down tax-free money to their heirs, but they also use the cash value in life insurance to create access to cash, tax-free.
  • Rule 72 T
    • You can avoid paying the 10% early withdrawal penalty by taking advantage of Internal Revenue Code 72(t). That’s shorthand for a provision in the tax code that allows you to take early distributions from your retirement plan or IRA and avoid the 10% penalty.
    • You can avoid that penalty as long as the distributions are made as part of a “series of substantially equal periodic payments” (or SOSEPP for short).
    • Once you start taking these distributions, you have to keep it going for the longer of five years or until you reach age 59-1/2.
  • Financial Organization
    • Avoid overpaying on taxes and make audits easier with a good bookkeeper.
    • Bad Bookkeeping is one of the top reasons people over-pay on taxes.
  • Build a coordinated Financial Team
    • Your team must communicate and work together in order for you to have an efficient and integrated strategy.
    • Lawyer
    • CPA
    • Insurance Specialist
    • Cash Flow Specialist
    • Financial Advisor
    • Use tax-free Ways to Extract Income.

 

  • Salary, bonuses, and distributions of your share of business profits are taxable. However, there are ways to benefit from your business without triggering the tax. 
  • Income-Flow Planning in Retirement.
    • A tax professional is needed to do this. 
    • Start preparing for this a minimum of about 5 years before retirement. If you want to do a Roth Conversion, at least 10 years before retirement is better. 
    • A financial advisor does not have the knowledge or legal ability to do this.
    • Make sure as little of your money as possible is taxable as regular income. This is especially important in retirement. Twenty years of retirement and a change of tax laws can dramatically destroy your lifestyle. 
  • Qualified Plans create a massive tax burden in retirement.
    • There are ways to create tax-free flows of cash that most financial advisors are unaware of, such as LIRPs and 412(e)(3) plans
  • Charitable Remainder Trust/Tax-exempt Trust.
    • Contribute Assets to the trust.
    • The trust owns the asset.
    • Sell the Asset.
    • No Tax is Allowed.
    • You get a lifetime Payout from the Trust if you give away 10% to Charity.
    • You pay tax on the distributions, normally at Capital Gains Rate.
  • Business Owners can open Retirement Account and have them tax-deductible.
    • Traditional IRA
    • Roth IRA
    • Solo 401 (K)
    • 412 (e)(3) plans 
    • There are other Retirement accounts most financial advisors and CPAs have never heard of that are used for high-income earners. These accounts allow you more safety and allow you to put much more money into them than a 401(K) or SIMPLE plan.
  • Put Family Members to work
    • Several Benefits to this.
    • Kids: Teach value and work ethic.
    • Kids will earn money to pay for stuff you otherwise would have paid for. 
    • They can even open an IRA account.
  • Health Insurance Premiums are Tax-Deductible for business owners.
    • Be sure to pay out of your business account.
  • REAL ESTATE has a lot of tax benefits.
  • Tax Loss Harvesting.
    • There are Capital Gains and Incomes Tax Strategies when harvesting losses

 

  • Take advantage of the massive tax savings Life Insurance gives you. 
    • This is a strategy used by the wealthy.
  • Specialized Trusts
  • Grantor Retained Annuity Trust
  • Manage your capital tax gains properly.
  • Re-categorize income
    • Income is taxed as regular income, capital gains, or as a dividend rate. Change how the money coming in is taxed
    • Shift income to a lower bracket.
    • Understand Marginal Vs Average Tax Rate.
  • Turn your sole-proprietor business into a corporation. 
    • These are taxed very differently. 
    • This strategy allows the owner to make money at a lower tax rate and claim expenses.
    • An example of how business structure can make a difference: Musicians can have the corporations hold the rights of the performer, and the money he’s paid goes to the corporation, not the individual.
  • Keep an eye on AGI

 

  • Many tax breaks, limitations, and additional taxes tee off of adjusted gross income (AGI) or modified adjusted gross income (MAGI). For example, you’ll avoid the 0.9% additional Medicare tax on earned income if your AGI does not exceed a certain threshold.
  • Make Smart Tax Elections.
  • There are several ways for how to reduce taxable income by being strategic about your business expenditures. When you acquire machinery, you can deduct the equipment in full, up to a certain dollar amount.  
  • However, if your business is just starting up or is not yet profitable, you can depreciate these expenses.  It might be better for your overall tax situation if you spread out the value of the purchases across multiple years.  This can help produce deductions for future years when you have more income to protect.
  • Manage your assets like a business. Create LLCs or corporations for each asset. 
  • Buy cars and lease your house in the business if related to the business.
  • Pay employees compensation through stock options. 
    • This creates additional opportunities
  • Pay employees through profit sharing or Phantom Stock Options
  • Incorporate in places with lower tax rates.
  • IRC Section 280A allows you to rent your entire home to your S corporation for 14 days or less during the year and get big tax deductions
    • There are some rules that must be followed when using this strategy. 
  • Reduce self-employment tax with an S corporation.
  • Evaluate the benefits of a C corporation.
  • “Conservation Easements” and Historical Sites With “Conservation easements”
    • you can give up your development rights for a piece of property that you own, so you’re unable to build on the property (but you could still use it for camping, recreation, or to temporarily park a trailer on, etc.)
  • “Historical easements”. If you buy a building in a historic district, you can get a tax deduction on it. With this rule, you give up the right to rebuild or change the historical aspect (or facade) of the building, but you can still remodel the inside and use it for business.
  • If the LLC is a management company that provides oversight and advice to owners of the assets, under certain circumstances, the expenses incurred by the LLC will be deductible as business expenses.”
  • Restricted Property Trust
  • HSA

 

Some of these strategies are more basic, while many of them are more complicated, but the bottom line is, they will all help you keep more of the money you are making. Start making an effort today to keep more of your money. 

 

The rich play by different tax rules than we do. Not because the tax rules don’t apply to them, but because they take the time to learn more.

 

 

 

 

The rich play by different rules than we do

 

Not because the tax rules don’t apply to them, but because they take the time to learn more. Tax law is constantly changing and is difficult. Those that do not spend time learning  about their tax situation and actively work with their tax professional to reduce taxes, will pay more taxes. 

 

Tax planning is an on-going activity and you should be meeting with your tax professional at least once a year. This is not something you should expect to have done for free. Good tax planners work diligently to keep up with changing tax laws. They deserve to get paid.

 

Below are some advanced ways to save on taxes

 

As the number of moving parts in your financial world increase, and the more flows of income you have, the more important tax planning becomes. 

 

In order to utilize the tax law, you have to do tax planning services. Taxes are most likely the biggest expense in your life.

 

Cash-Flow Planning and Tax Planning can create much bigger returns than what you are getting in your 401 (K), IRAs, and other investments 

 

These strategies are for informational purposes only. Do not take any of this as financial or tax advice. Some of these strategies may apply to your specific situation and some may not. Consult your tax professional to see if any of these strategies apply to your specific situation.    

 

If you enjoy over-paying on taxes, there is no reason to do tax-planning. If you don’t enjoy giving the government money call us today we will help you stop giving your money away. 

 

  • Life Insurance
    • The wealthy not only use life insurance to pass down tax-free money to their heirs, but they also use the cash value in life insurance to create access to cash, tax-free.
  • Rule 72 T
    • You can avoid paying the 10% early withdrawal penalty by taking advantage of Internal Revenue Code 72(t). That’s shorthand for a provision in the tax code that allows you to take early distributions from your retirement plan or IRA and avoid the 10% penalty.
    • You can avoid that penalty as long as the distributions are made as part of a “series of substantially equal periodic payments” (or SOSEPP for short).
    • Once you start taking these distributions, you have to keep it going for the longer of five years or until you reach age 59-1/2.
  • Financial Organization
    • Avoid overpaying on taxes and make audits easier with a good bookkeeper.
    • Bad Bookkeeping is one of the top reasons people over-pay on taxes.
  • Build a coordinated Financial Team
    • Your team must communicate and work together in order for you to have an efficient and integrated strategy.
    • Lawyer
    • CPA
    • Insurance Specialist
    • Cash Flow Specialist
    • Financial Advisor
    • Use tax-free Ways to Extract Income.

 

  • Salary, bonuses, and distributions of your share of business profits are taxable. However, there are ways to benefit from your business without triggering the tax. 
  • Income-Flow Planning in Retirement.
    • A tax professional is needed to do this. 
    • Start preparing for this a minimum of about 5 years before retirement. If you want to do a Roth Conversion, at least 10 years before retirement is better. 
    • A financial advisor does not have the knowledge or legal ability to do this.
    • Make sure as little of your money as possible is taxable as regular income. This is especially important in retirement. Twenty years of retirement and a change of tax laws can dramatically destroy your lifestyle. 
  • Qualified Plans create a massive tax burden in retirement.
    • There are ways to create tax-free flows of cash that most financial advisors are unaware of, such as LIRPs and 412(e)(3) plans
  • Charitable Remainder Trust/Tax-exempt Trust.
    • Contribute Assets to the trust.
    • The trust owns the asset.
    • Sell the Asset.
    • No Tax is Allowed.
    • You get a lifetime Payout from the Trust if you give away 10% to Charity.
    • You pay tax on the distributions, normally at Capital Gains Rate.
  • Business Owners can open Retirement Account and have them tax-deductible.
    • Traditional IRA
    • Roth IRA
    • Solo 401 (K)
    • 412 (e)(3) plans 
    • There are other Retirement accounts most financial advisors and CPAs have never heard of that are used for high-income earners. These accounts allow you more safety and allow you to put much more money into them than a 401(K) or SIMPLE plan.
  • Put Family Members to work
    • Several Benefits to this.
    • Kids: Teach value and work ethic.
    • Kids will earn money to pay for stuff you otherwise would have paid for. 
    • They can even open an IRA account.
  • Health Insurance Premiums are Tax-Deductible for business owners.
    • Be sure to pay out of your business account.
  • REAL ESTATE has a lot of tax benefits.
  • Tax Loss Harvesting.
    • There are Capital Gains and Incomes Tax Strategies when harvesting losses

 

  • Take advantage of the massive tax savings Life Insurance gives you. 
    • This is a strategy used by the wealthy.
  • Specialized Trusts
  • Grantor Retained Annuity Trust
  • Manage your capital tax gains properly.
  • Re-categorize income
    • Income is taxed as regular income, capital gains, or as a dividend rate. Change how the money coming in is taxed
    • Shift income to a lower bracket.
    • Understand Marginal Vs Average Tax Rate.
  • Turn your sole-proprietor business into a corporation. 
    • These are taxed very differently. 
    • This strategy allows the owner to make money at a lower tax rate and claim expenses.
    • An example of how business structure can make a difference: Musicians can have the corporations hold the rights of the performer, and the money he’s paid goes to the corporation, not the individual.
  • Keep an eye on AGI

 

  • Many tax breaks, limitations, and additional taxes tee off of adjusted gross income (AGI) or modified adjusted gross income (MAGI). For example, you’ll avoid the 0.9% additional Medicare tax on earned income if your AGI does not exceed a certain threshold.
  • Make Smart Tax Elections.
  • There are several ways for how to reduce taxable income by being strategic about your business expenditures. When you acquire machinery, you can deduct the equipment in full, up to a certain dollar amount.  
  • However, if your business is just starting up or is not yet profitable, you can depreciate these expenses.  It might be better for your overall tax situation if you spread out the value of the purchases across multiple years.  This can help produce deductions for future years when you have more income to protect.
  • Manage your assets like a business. Create LLCs or corporations for each asset. 
  • Buy cars and lease your house in the business if related to the business.
  • Pay employees compensation through stock options. 
    • This creates additional opportunities
  • Pay employees through profit sharing or Phantom Stock Options
  • Incorporate in places with lower tax rates.
  • IRC Section 280A allows you to rent your entire home to your S corporation for 14 days or less during the year and get big tax deductions
    • There are some rules that must be followed when using this strategy. 
  • Reduce self-employment tax with an S corporation.
  • Evaluate the benefits of a C corporation.
  • “Conservation Easements” and Historical Sites With “Conservation easements”
    • you can give up your development rights for a piece of property that you own, so you’re unable to build on the property (but you could still use it for camping, recreation, or to temporarily park a trailer on, etc.)
  • “Historical easements”. If you buy a building in a historic district, you can get a tax deduction on it. With this rule, you give up the right to rebuild or change the historical aspect (or facade) of the building, but you can still remodel the inside and use it for business.
  • If the LLC is a management company that provides oversight and advice to owners of the assets, under certain circumstances, the expenses incurred by the LLC will be deductible as business expenses.”
  • Restricted Property Trust
  • HSA

 

Some of these strategies are more basic, while many of them are more complicated, but the bottom line is, they will all help you keep more of the money you are making. Start making an effort today to keep more of your money. 

 

The rich play by different tax rules than we do. Not because the tax rules don’t apply to them, but because they take the time to learn more.

 

 

 

Succession Planning

Succession Planning

What Is Your Plan to Leave Your Business?
What if You Can’t Work Tomorrow?

Study after study reveals the majority of business owners, anywhere from 60-80%, lack a succession plan.  Of those business owners, 50-70% do not have a specific transition plan. You have spent a large part of your life and poured your heart, soul, and money into your business, making sure it is successful. You, your family, your employees, and your employees’ families all rely on your business for their livelihood.  

You will exit your business at some point. We all do. We may retire. We may sell our business, or we may exit by force, by way of a disability, sickness, a changing economy, or due to government regulations. All of these life events threaten our business, our family, and our lifestyle. Throw in other complex issues, such as concerns for estate taxes and the changing workforce, and we all have a potential business catastrophe in the making. We can’t control most of these events, but we can de-risk our business and build a hedge against the derailing of our business with proper planning. 

What is your succession plan?

Succession planning is part of the estate plan that is focused on the ongoing operation and prosperity of your businesses or company. This can be a small family business or a larger business. Effective business planning is concerned with supporting the growth and ongoing operation of your business while equipping the business to withstand difficult circumstances, such as losing an owner unexpectedly.  

The issues within the scope of succession planning can be summarized as business succession and continuity planning, business asset planning, planning for key persons, and implementing life insurance strategies for key people. These strategies include executive bonus plans, deferred compensation plans, and split-dollar plans. 

Without a clear succession plan, disputes can arise among partners—or their surviving spouses—that will lead to loss of time, lead to expensive litigation, and possible business failure.

One of the most often overlooked business documents of a business is a Buy-Sell agreement. 

It is not just enough to have a Buy-Sell agreement, but it needs to be funded correctly and updated yearly. As your business makes changes and grows, so will the business’ needs and your family’s needs. If you do not have a properly funded Buy-Sell agreement in place, your business and your family’s income are at risk. 

What Is A Buy-Sell Agreement?

It is a written legal contract between a business and its owners that specifies how a specific event, such as death, divorce, disability,  or departure for any reason, affects the management and control of the business.

A Few things it Accomplishes

  • Facilitates the orderly transfer of business interests when business owners depart from the business due to certain specified events
  • Establish a value for the purchase price of the business and for estate-tax purposes
  • Creates a legal obligation for the departing owner to sell his or her business interest, and a legal obligation for the buyer to purchase the interest
  • Creates a market for the departing owner’s interest in the business when no such market exists in the absence of such an agreement
  • Ensures that the survivor of a deceased owner is compensated for the deceased owner’s interest
  • Prevents a deceased’s interest from being locked up in probate
  • Provide a source of funds

Basic approaches to structuring Buy-Sell Agreement

Cross-Purchase Buy-Sell Arrangement: 
  • Anticipates that a co-owner will be the buyer of a departing owner’s business interest. It obligates the remaining owner to buy out the interest of the deceased or departing owner.
Entity Purchase Buy-Sell Arrangement:
  • A buy-sell agreement between the business and the individual owners
  • The business will be the buyer of a deceased/departing owner’s business interest. (Where the business is in the form of a corporation, this buy-sell agreement is known as a stock redemption agreement.) 
The One-Way Buy-Sell Arrangement:
  • A legal contract between the business owner and some third party addressing the disposition of the owner’s business interest upon his/her death, disability, retirement, or other departure. 
  • It obligates the purchaser to buy out the interest of the deceased or departing owner.
Wait-and-See Approach
A Hybrid Approach: 
  • At the time of the structuring of the arrangement, it is difficult to determine if one method is better than the other. 
  • Generally, defers the choice until a triggering event occurs.
  • Generally, allows the business with the first right-of-refusal to purchase the deceased/departing owner’s interest. 
  • The remaining owners are then given the option to purchase the business interest, but if they do not, the business is obligated to purchase the remaining interest. 

What are Triggering Events?

Events that may prompt the purchase of a departing owner’s interest by the remaining owners or the business are called “triggering” events.

A trigger event normally prompts one of three events:

  • an option of a buying owner to buy out the selling owner’s interest.
  • an option of the selling owner to force the buying owner to buy him/her out.
  • a mutual obligation on both, the buying-owner to buy, and the selling-owner to sell the ownership interest.

Although some transfers of interest are clearly advantageous and should be permitted, others may not be as desirable.

In these situations, it may be better to force the sale of the business and for the remaining owners to purchase an owner’s interest. It could be particularly advantageous if the departing owner’s interest is on the verge of being transferred to a potentially undesirable owner, such as a soon-to-be ex-spouse. 

Common triggering events

  • Death
  • Disability
  • Termination of Employment
  • Divorce
  • Bankruptcy
  • Pledging of an Owner’s Interest

Are you comfortable with your current business plan?

There is nothing wrong with getting a second set of eyes on your business plan. It is important to review it at least once a year. Do you know what your current plan will accomplish in these situations? These are only a few problems that can arise and destroy your business. 

Death of a Business Owner

Do you want to inherit the owner’s spouse, ex-spouse, or other family members? Should the owner’s heirs inherit the role of ownership or is it more desirable for the surviving owners of the business to be able to buy out the interest of the deceased owner?

  • What if they know nothing about the business?
  • What if they want total control?
  • What if they just want the money from the business? Will they force the sale of it? 
  • How will you finance buying the business? Can you finance it? How much will you have to buy it for?

 Disability

  • How is disability defined?
  • Many Buy-Sell agreements do not have the proper definition of what a disability is. Oftentimes, there is a discrepancy between what a Buy-Sell agreement says a disability is and what your insurance says a disability is.
  • Agreements that rely on the definition of “disability” within an existing disability policy may require the opinion of a physician or may depend on the interpretation of a formula that takes into account the tasks the owner performs in the normal course of business.

Common Causes of a Disability

  • Depression
  • Arthritis 
  • Heart Disease
  • Stroke
  • Cancer
  • Nervous system Disorders
  • Diabetes
  • Mental Illness, including depression
  • Injuries sustained from accidents, such as auto accidents
  • Pregnancy 

Termination of Employment

Depending on the agreement and how your business is set up from a legal structure and a tax structure, the owner(s) of the business may or may not be an employee. This is vital in structuring a Buy-Sell agreement correctly. 

  • Are the owner’s employees of the business?
  • Or otherwise, actively engaged in the business?
  • What if an owner steps down, changes roles in the business, retire, or otherwise terminates employment with the business?
  • Should the business owner be able to sell their business interest to anyone? Or should this trigger an event where the other business owners get First-Right-of Refusal

Divorce

  • Do you want your business partner’s ex-spouse as your new business partner?
  • There is no way to guess how a divorce judge will disperse a business owner’s assets (which include the owner’s interest in the business). 
  • Buy-Sell agreements can allow the divorcing owner to have the first option to purchase his or her interest back from his or her soon-to-be ex-spouse.
  • Buy-Sell agreements can often provide that if the divorcing owner does not exercise this right, then the remaining owners and the business have the option to buy the owner’s interest from the divorcing owner’s spouse.

Bankruptcy

  • Do you want the bank as a business partner making day-to-day decisions?
  • Most buy-sells prepare for the bankruptcy of an owner by mandating that the remaining owners and the business will have an option to buy out the bankrupt owner’s interest, rather than be forced into having the bank as a business partner.

Determining the Purchase Price

Once you have defined the types of events that can trigger the purchase of an owner’s interest in a business, you need to set a price in which the business will be bought. 

When a Buy-Sell agreement is established, each owner will not know whether he/she will be on the buying side or the selling side. It is best to put into place a neutral procedure for determining the price and value of a business. 

  • The foundation of this planning is built upon an accurate estimate of the value of your business.
  • You may have some opinion of what your company is worth, but what could your business be sold for if put on the market?
  • With the proper planning, you can increase how much you sell your business for
  • Fair market value depends on many variables. 
  • Legal and tax considerations make the valuation process even more complex. 

Ways to Approach the Evaluation of the Business

  • Do business owners have the time or discipline to get together every year to have a debate and determine the value of the business?
  • Will optimism be high, and an unrealistic value is assigned?
  • What if an owner is planning to leave and wants the value of the business much higher than the true value?

Agreement of the owners can be ineffective, difficult to determine, and expensive to determine. An owner may want a specific formula for valuing the business, but the formula may not reflect the true value of the business.

The business Valuation clause outlines that a business valuation expert will assess the appropriate method to value the business.

There should include ground rules such as:  

  • How the price is determined 
  • Who can or can’t be a buyer
  • How a business sale will be funded

Business Valuation Formulas

  • Book Value and Adjusted Book Value
  • Capitalization of Earnings
  • Discounted Cash Flow
  • Comparable
  • Accepted discounts, including lack of marketability
  • Minority ownership
  • May get out when we want to get out. May be forced to get out

Uncle Sam Needs his money too!

  • Buy-sell agreements have tax implications
  • There are certain ways that a sale or buyback of a company can be structured to minimize taxes or to allow them to be paid overtime
  • Without consideration of tax matters, an owner planning to fund his or her retirement by selling shares could wind up with drastically reduced proceeds
  • If a corporation uses appreciated property in redemption, the corporate-level gain is triggered
  • The cost basis in the interest acquired needs to be considered if payment over time is desired, then care should be taken to determine whether the purchaser will be able to deduct interest payments

Issues by Entity

These are only a few issues that could arise.

LLC

  • Certain events can cause a member to cease being a member of the LLC. Usually set forth in the company’s operating agreement. Such events can include:
    • The expulsion of a member. If there are no provisions for such an expulsion, dissolution of the LLC may be the only way to get rid of a member. This can create multiple problems.
    • A member may assign their ownership interest to a third-party buyer, creditor, or involuntarily to a bankruptcy trustee.
    • Death or incapacity of a member. 
  • When a member does terminate, is the member still entitled to allocations and distributions?
  • What is the price at which the remaining members of the LLC can purchase the withdrawing member’s interest?

Partnership

  • Provisions dealing with expulsion and the rights of the partners and the partnership upon expulsion of a partner from the business.
    • Active withdrawal
    • Death
    • Incapacity 
    • Retirement
  • Will a withdrawal automatically result in the termination of the partnership?
  • How to value a partnership interest upon withdrawal, and how that purchase price is to be paid to the former partner or the partner’s estate.

S Corporations

S corporations have strict definitions of what a permissible shareholder is. Because of this, much of the focus for these organizations is on the protection of their special tax status.

Voluntary or involuntary transfer of shares may result in a Shareholder that is not allowed to own stock, becoming a stock owner. In this situation,  then the S corporation could lose its tax status. Such provisions and issues include the following:

  • Quarterly distributions of dividend income will allow shareholders to pay the taxes owed on allocations to income.
  • Transfers to trusts for estate planning purposes should be allowed, but only if the trust meets the specific requirements.
  • If a transfer that jeopardizes the corporation’s “S” election should occur, an immediate option in the remaining shareholders and/or the corporation to purchase the interest should be triggered.
  • Careful consideration should be given to loans, stock options, restricted stock, to ensure no impermissible second class of stock is created which could terminate the S corporation election.

Estate Planning Considerations

  • Continuity and Control 
    • An agreement clearly stipulates what happens to the business owner’s interest in the business upon an owner’s death enables the business to continue operating with little interruption.
  • Eliminating Need to Negotiate Price
    • A detailed, pre-determined pricing mechanism set forth in a buy-sell agreement can remove the burden of negotiating a purchase price from the heirs.
    • This ensures the heirs get a fair price for the deceased’s interest in the business.
  • Fixing Interest Value for Estate Tax Purposes.  
    • A buy-sell agreement allows the opportunity to set the value of a decedent’s ownership interest for estate tax purposes. 
    • If the decedent will not have a taxable estate, then it may not be desirable to set the price as low as possible. This will only increase the amount of gain in the hands of heirs when the business is eventually sold. 
  • Preservation of Entity Tax Status.  
    • In an S corporation, allowing shares to become owned by the wrong kinds of shareholders can jeopardize the S corporation’s status. 
    • In general, if shares are allowed to pass to a trust, the trust should be examined to ensure it complies with the S corporation requirements.
  •  Liquidity to the Estate.  
    • A properly funded buy-sell agreement can provide much-needed liquidity to a deceased owner’s estate. 

We are here to help

As you can see, putting together a solid succession plan can be complicated. There are a lot of moving parts. It requires an expert team of lawyers, business advisors, life insurance specialists, and a CPA experienced in this field. It may also include a wealth manager and an advisory board. 

As with everything else, it is important to be proactive instead of reactive. DO NOT WAIT UNTIL RETIREMENT- or worse, until you are unexpectedly forced to exit your business- to put a plan in place. In order to sell a best-in-class business, it takes time to evaluate the business, to find a buyer, and to improve in areas that need improving. 

Waiting too long to plan may prevent you from reaching your goals and will drastically increase your risks. 

Call us today at 785-430-3717 so we can de-risk your business. Or contact us here

Disclaimer
  • This content is for general informational purposes only.
  • It is not intended to provide fiduciary, tax, or legal advice and cannot be used to avoid tax penalties, nor is it intended to market, promote, or recommend any tax plan or arrangement.
  • We do not give legal advice.
  • You are encouraged to consult with your legal, tax, and financial professionals for specific advice or product recommendations.
  • Every situation is different and requires a team of knowledgeable professionals working to create the correct agreement. 
  •  Andrew Keehn and Blackstone Wealth Protectors expressly disclaim all liability for anything the reader chooses to do or to omit doing in reliance upon this document’s contents. 
  • Posting and receipt of this information is not intended to create, nor does it create or constitute, a client relationship between Andrew Keehn or  Blackstone Wealth Protectors and the reader.