mark r. diederich, cfp®, lutcf, cpcu - mbba · moe and curly howard are 50% - 50% partnership in...
TRANSCRIPT
Mark R. Diederich, CFP®, LUTCF, CPCU
26 Years in Financial Services Industry
17 Years, CEO TDA Insurance & Financial
Certified Financial Planner
Life Underwriter Training Council Fellow
M.B.A. University of Detroit
B.B.A. Central Michigan University
Licensed Property & Casualty Insurance Agent
Licensed Life, Health & Disability Insurance Agent
F.I.N.R.A. Registered Representative (6,26,65)
M.B.B.A Member since 2010
What is a Business Succession Plan
Why Does Every Business Need One
The Components of a Succession Plan
How to Start the Process
Moe and Curly Howard are 50% - 50% Partnership in Acme Tool and Die LLC Established in 2000.
Curly is “Mr. Inside” and Moe is “Mr. Outside”
Each 40 years old
Both Married with children
Curly dies unexpectedly in an accident in the factory.
Curly’s wife of 20 years needs there share of the $1 Million income her husbands business is generating to maintain life style ◦ She would like Moe to pay her $10 Million lump sum or ◦ Continue to pay her $500,000 a year indefinitely and she
will become Moe’s partner.
Moe can only afford to pay her $1 Million and will need to replace “Mr. Inside” to continue to run their business
They did not have a buy-sell agreement.
They go to court because they can’t agree on how to buy out Curly’s wife. ◦ Spend Thousands of Dollars in attorney fees
The finally agree on the value of the business being $15 Million dollars and Curly’s wife share is $7.5 Million. ◦ Moe has resources to come up with $1 million but has to borrow
$6.5 Million.
The distraction of this transaction and the payment of the interest and principal on the loan erodes all of Moe’s working capital.
1 year later Moe’s accepts an offer to sell the business to a
competitor for the balance of the loan. Moe walks away with nothing!
A plan put in place to ensure the survival of the business if something happens to one of its owners or key employees. ◦ Death
◦ Disability
◦ Retirement
◦ Loss of Key Employee
Customers who do business with you, because of you, could go elsewhere.
Key employees could start looking for other
opportunities Family members or business partners could
begin disagreeing over “who gets what” and who should make day-to-day business decisions.
You could become business partners with your
partner’s spouse or beneficiaries that may have little or no business experience or knowledge.
A potential shortage of cash, especially following death
Difficulty paying debts.
Inadequate income for you, your spouse and your heirs.
The liquidation of assets and ultimately, your company, to pay federal and state taxes.
Bank may call loans or lines of credit
Inequitable treatment of heirs
Estate erosion
Failure of business
1st Step establish a properly structured Buy-Sell Agreement ◦ Pre-determine who will receive your business in
case of death, disability or retirement of an owner or key employee
Pre-determine who will receive your business Set the purchase price and terms of payment Establish the value of your business for federal tax
purposes Specify how the transfer will be funded Provide the cash needed to pay federal and state
death taxes, debts and other estate settlement cost
Only 6 out of 10 Businesses have a formal Succession Plan
Estate Liquidity – to help pay federal and state taxes, debts and probate expense.
A Source of Income- money you and/or your family can use to maintain your lifestyle.
A Known Purchaser and a set price – for the sale and purchase of your or your partner's business interest.
Tax Valuation – the value of the business, or the share being transferred, is established for federal tax purposes.
Successor ownership and management – so the business can continue without interruption or outside interference.
A funding vehicle – to provide retirement income.
Improved relationships – not only with business partners and family members, but also with business creditors.
Options: ◦ Business Cash – Requires that a large sum of money be readily
available.
◦ Sinking Fund – Requires setting a side a portion of capital each year until adequate funds are available
◦ Borrowed Funds – Requires the ability to be able to borrow and interest must be paid
◦ Installment Payments – Requires ongoing principal and interest payments to spouse and heirs and is dependent on successful business continuation
◦ Life and Disability Insurance – Provides guaranteed funds whenever it is needed and proceeds are general exempt from income taxation.
The performance information represented is based on hypothetical valuations for a male, age 45, standard non-tobacco, 20 pay premium to endow the policy at age 100 for illustrative purposes.
A properly drafted buy-sell agreement will establish the value of a business for the purposes of federal estate and gift taxes as long as it meets 3 requirements:
◦ It must be a genuine business arrangement ◦ It must not be a device to pass the business interest
to family member for less than full value. ◦ It must be comparable to similar arrangements
entered into by other persons in an “arms length” transaction.
Book Value – Assets minus Liabilities
Capitalization of Earnings – multiply earnings by a capitalization factor
Formula – utilize a formula that incorporates several different factors
Appraisal – use a professional appraiser to value the business
Fixed Price – fix the price in the Agreement
No Buy-Sell Agreement ◦ Estate of Harry S. Leyman – Auto Dealer
Estate Estimate of Business’s value per share: $536
IRS value per share: $700
Court decision: $630
Tax Ramification: $94 per share
◦ Estate of Edward E. Hansoom-Real Estate Developer
Estate Estimate of Business’s value per share: $50
IRS value per share: $100
Court decision: $100
Tax Ramification: $50 per share
With a Buy-Sell Agreement ◦ Estate of John T. H. Mitchell – Advertising Agency
Estate Estimate of Business’s value per share: $123
IRS value per share: $349
Court decision: $123
Tax Ramification: $0 per share
◦ Estate of Slocum vs. US Hospital
Estate Estimate of Business’s value per share: $100
IRS value per share: $1,109
Court decision: $100
Tax Ramification: $0 per share
Note: These results are based on specific cases that may or may not be representative of other situations and cases.
L.T. Capital Gains on the sale of a business ◦ 0% Rate if a person is in the 10% and 15% tax
brackets ◦ 15% Rate if a person is in the 25%, 28%, 33%, or
35% tax brackets ◦ 20% Rate if a person is in the 39.6% tax bracket
Estate and Death Taxes ◦ Exemption $5.25 Million ◦ 40% Top Tax Rate
Entity Buy-Sell – the business entity agrees to purchase the interest of individual owners.
Cross Purchase –the individual owners all agree to
purchase the interest of the other owners. Partnership Administration Succession Strategy
(P.A.S.S.) – the shareholders of the business forms a second partnership the individual owners all agree to purchase the interest of the other owners, the partnership then owns and is beneficiary of the life insurance policy covering each owner. The owners transfer cash to the partnership as a capital contribution to pay the premiums.
Business
Insurance
Company
Owner 1 Owner 2
Pre
miu
ms
Death
Benefi
t
Advantages Disadvantages
Instant Market for the business interest is created
Insurance funding may be subject to alternative minimum tax in some larger corporations
The price and terms are specified in advance
Insurance proceeds and cash values could be subject to the claims of business creditors
The business is allowed to continue without interruption
Surviving owner(s) receive no increase in the cost basis of their shares.
The value of the business interest is established for estate planning purposes
Estate liquidity is provided to help pay taxes and debts
The business pays the premium
If the owners differ in age or health, unequal costs can be borne by the corporation
Business
Insurance Company
Owner 1 Owner 2
Estate
Stock
Purchase Price
Premium on owner 1
Premium on owner 2
Death Benefit
Advantages Disadvantages
Instant Market for the business interest is created
Multiple policies and increased administration are needed
The price and terms are specified in advance
Premium inequities could result due to differing ages and health of each owner
The business is allowed to continue without interruption
At retirement, the transfer of insurance policies to the retiring owner could result in taxable income.
The value of the business interest is established for estate planning purposes
Estate liquidity is provided to help pay taxes and debts
Shares purchased by the remaining owners receive an increase in cost basis
Insurance proceeds are not subject to alternative minimum tax, or to the claims of the creditors.
Corporation
Insurance Company
Owner 1 Owner 2 Owner 3
123 Partnership
Owner 1
Bonus Premium Bonus Premium
Buy-Sell
Cash for Premium
Buy-Sell
Cash for Premium
Policy Premium Death Benefit
Death Benefit Death Benefit
Advantages
Requires only one insurance policy per owner
Avoids the corporate alternative minimum tax
Minimizes inequities among partners in the cost of insurance coverage through special allocations
Provides a full basis increase to the surviving owners/partners
Allows the surviving owners to distribute the insurance proceeds themselves, generally free of income taxes, in order to accomplish the corporate buy-out.
Permits the transfer of the policy insuring a departing owner to that owner without recognition of any policy gain, and without raising any “transfer for value” concerns.
The Buy-Sell Provision should be a part of an operating agreement as soon as a business is formed ◦ Best time to have an objective view of the best way to
value a business is before there is issues, greed and other factors that influence conflict.
◦ The younger and healthier you are the less costly it is to fund a plan with life or disability insurance.
If the business is already up and running then the best time to put a business succession plan is immediately before something happens.
Age of Each Person
To any one person
To any one person out of two people
To any one person out of three people
30 14.9% 27.6% 38.4%
35 14.4% 26.7% 37.3%
40 13.8% 25.7% 36.0%
45 13.0% 24.2% 34.1%
50 11.6% 21.8% 30.9%
Chances of death occurring prior to age 65
Source: 2007 Field Guide,. National Underwriter Company. Assumes all individuals are male and same age
Consult the Appropriate Professionals to develop a sound plan: ◦ Attorney – Draft the proper legal agreements
◦ CPA – Determine proper Corporate formation, assist with business valuation calculations and make sure plan minimizes taxes.
◦ Financial Planner/Insurance Professional – Determine the proper funding mechanism’s in the case of death, disability, retirement or other departure.
Consult with owners on importance of having a business succession plan in place
Assist owners with business valuations
Refer owners to the proper professionals
Mark R. Diederich, CFP, LUTCF, CPCU TDA Insurance & Financial Agency LLC 43450 W. Ten Mile Rd Novi, MI 48375 www.TDAnow.com PH: 1-877-832-6690 Fax: 1-248-869-2234 Email: [email protected]