L A W O F F I C E S

GIVNER & KAYE A PROFESSIONAL CORPORATION

SUITE 445 12100 WILSHIRE BOULEVARD

LOS ANGELES, CALIFORNIA 90025 www.GivnerKaye.com

BRUCE GIVNER (bruce@GivnerKaye.com) OWEN D. KAYE (owen@GivnerKaye.com) KATHLEEN GIVNER (kathy@GivnerKaye.com) NEDA BARKHORDAR (neda@GivnerKaye.com)

PHONE (310) 207-8008 (818) 785-7579

FAX (310) 207-8708 (818) 785-3027

March 3, 2016

Moving Your Business To The Next Generation:

Gift Tax; Estate Tax; Income Tax; Employee Benefit; And Psychological Issues

1. Introduction.

This discussion assumes the parents’ likely exit is a transfer of the business to the next generation rather than a sale to an outsider. However, when a child is young or newly with the business, we cannot be certain. The child may not want to join or remain in the business. Therefore, we must always keep an eye open to the possibility that, despite the parents’ wish to see the business continue into the next generation, there is a chance that it will be sold to an outsider. Therefore, the same steps that we would advise to get the business ready for a sale to an outside cash buyer should help make the business stronger for a transfer to the next generation.

1.1. Advisors. 1.1.1. CPA as the one with the most constant client contact and highest credibility.

1.1.2. Insurance agent as the one with sometimes the best motivation and sales skills who sees the client to talk about significant transitional events.

1.1.3. Estate Planning lawyer who talks about transition of wealth; feelings about the heirs; and equalization.

1.1.4. Business lawyer as the one most likely to document the business transition. 1.1.5. Lenders who have an interest in continuity of the business to pay off the loan. 1.1.6. Money managers tied to investment banks. 1.1.7. Traditional organizations: Estate Planning Councils. 1.1.8. Newer organizations:

1.1.8.1. Business Enterprise Institute (Exit Planning For Advisors – become a Certified Exit Planner).

1.1.82. Exit Planning Institute (The $10 Trillion Dollar Opportunity; Certified Exit Planning Advisor Program – CEPA – 5-Day Executive Style MBA Program).

1.2. Events. 1.2.1. Child joins the business. Obvious old joke. 1.2.2. Two children in the business. 1.2.3. Children in the business and children not in the business.

1.2.3.1. The Equalization Clause problem. 1.2.3.2. Values now or at death? 1.2.3.3. Starting the equalization now or waiting until death. 1.2.3.4. Non-business assets, e.g., building on which the business sits,

liquid assets, to equalize the outside children. 1.2.3.5. Inadequate non-business assets to equalize the outside children.

Can you possibly imagine (in your wildest dreams) what asset might be used to do that??

1.2.3.6. Do inside children earn some of what they have? Or is it all a gift? 1.2.3.7. Problems with second marriages: 3 dimensional chess. 1.2.3.8. Compounding the problem: key employees who want/deserve

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Income Tax; Employee Benefit; And Psychological Issues March 3, 2016 Page 2 of 8

stock. Always use phantom. 1.2.4. Skipping the children and going straight to the grandchildren!!

1.2.5. Myocardial infarction and visions of death. 1.2.6. Parent’s disability. 1.2.7. Desire to reduce time at the business. 1.2.8. Desire to completely retire. 1.2.9 Wish to turn attention to a new business. 1.2.10. Divorce and/or remarriage.

1.3. Structures. 1.3.1. The once-a-year lunch with an investment banker. 1.3.2. The independent board of directors (or advisory board).

1.3.2.1. Who? 1.3.2.2. Compensation. 1.3.2.3. Format. Once a quarter. At a hotel. 1.3.2.4. Client resistance. One out of 10 clients. 1.3.2.5. Continuous success. 1.3.2.6. Connection to estate tax planning success.

1.3.3. Format Of The Business. 1.3.3.1. Preference for an “S” corporation. 1.3.3.1.1. Easiest to transfer to heirs. 1.3.3.1.2. No “double” tax on a sale. 1.3.3.2. Seldom used “C” corporations. 1.3.3.2.1. Good to accumulate capital. 1.3.3.2.2. Potential California tax benefit if no §338(h)(10).

1.3.3.2.3. Easier transition to “S” since PATH (Protecting Americans From Tax Hikes Act of 2015) change to §1374.

1.3.3.3. Seldom used “LLCs.” 1.3.3.3.1. California LLC gross receipts tax. 1.3.3.3.2. Easy to define different classes of interests. 1.3.3.4. Difficulties when not owned by one set of parents. 1.3.3.4.1. Two siblings. Divide before first generation is gone? 1.3.3.4.2. Two strangers. Having heirs from each get along? 1.3.3.4.3. Equal owners. 1.3.3.4.4. Unequal because lesser owner was the worker-bee. 1.3.4. Type Of Business. 1.3.4.1. Professional Practice. 1.3.4.1. One child.

1.3.4.2. Son and son-in-law!!! 1.3.4.2. Vanilla manufacturing business. 1.3.4.3. Import-export business requiring lots of travel. 1.3.4.4. Business requiring special expertise, e.g., IP.

1.3.4.5. Requires large personal guaranties, e.g., mortgage or equipment leasing.

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Moving Your Business To The Next Generation: Gift Tax; Estate Tax;

Income Tax; Employee Benefit; And Psychological Issues March 3, 2016 Page 3 of 8 2. Gift Tax. 2.1. In General. 2.1.1. Large disparity between client’s view of value and appraiser’s view of value. 2.1.2. Large DLOM and DLOC for closely held businesses. 2.1.3. If value under exclusion, IRS Form 709 unlikely to be audited.

2.1.4. Must file a gift tax return showing a nominal gift even if a transfer for full FMV to force statute of limitations to run. IRC §6501(c)(9); §2001(f).

2.1.5. The 3-Legged Stool. See article. 2.1.6. Potential use of SCIN-GRAT to double the discount opportunity. See diagram.

2.2. Impact (in our practice) of Karmazin, Woelbing and Davidson audits. 2.2.1. Most important when health is a concern. 2.2.2. Do not use a note longer than the parent’s life expectancy. §2036. 2.2.3. Use at least a 10% downpayment in any sale. More is better.

2.2.4. Make sure the heirs’ trust has plenty of assets left after making the downpayment. Seed capital.

2.2.5. If possible, have the heirs separately guaranty the note and have their financial statements available.

2.2.6. If any issue about health, get at least 2 opinions that there is a greater than 50% chance of surviving a year. IRS may still challenge.

2.2.7. Don’t rely on the AFR. Get as close to market rate of interest as possible. 2.2.8. Don’t use an interest only note. Amortize over 30 years (even if note is for a

shorter period of time). 2.2.9. Have children’s trust and parents represented by separate counsel. Show

evidence of negotiations. 2.2.10. Parent cannot be reliant on transferred assets to maintain standard of living.

Have the CPA prepare (and preserve) an analysis of standard of living. 2.3. “S” corporations the easiest due to GRATs. 2.4. “C” corporations. 2.4.1. Most difficult since a GRAT must be funded with double-taxed dividends. 2.4.2. Large discounts still available. 2.4.3. “S” election and monitor the recognition of B.I.G. 2.5. LLCs. 2.5.1. GRATs make it easy. 2.5.2. Frozen preferred interests for parents are worth considering. 3. Estate Tax. 3.1. Will there even be an estate tax after the next election? 3.2. Is there a reason to save the exclusion for the estate tax? 3.3. What if the client has little or no exclusion left? 3.3.1. T-CLAT. 3.3.1.1. $16,700,000 closely held “S” corporation. 3.3.1.2. Generates $1,021,785 per year dividend. 3.3.1.3. 60% (to reflect 40% discount) = $10,020,000. 3.3.1.4. Assume a 2% §7520 rate.

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Income Tax; Employee Benefit; And Psychological Issues March 3, 2016 Page 4 of 8 3.3.1.5. $1,021,785 per year for 11 years. 3.3.1.6. Multiply that payment by IRS Publ. 1457 factor of 9.7868. 3.3.1.7. Value of annuity = $10,000,005. 3.3.1.8. Estate tax is on $10,020,000 - $10,000,005 = $19,995, 3.3.1.9. If actual grow is 8%, remainder to heirs will be $6,308,281. 3.3.2. GRATs can reduce the transfer tax to near zero. See charts. 3.3.3. Parents can’t use a CRT to sell to the children due to self-dealing rules. 3.4. GSD. 3.2.1. Quick way to get a large discount.

3.2.2. Leveraged way to get a large discount. 3.2.3. Not dependent on parent’s health. 3.2.4. Benefit of an opinion letter.

3.3. Post-mortem planning. 3.3.1. Mellinger on first spouse’s death. 3.3.2. T-CLAT (see above). 3.3.3. Graegin note. 3.3.4. Thoughtful appraisals. 3.3.5. Disclaimer planning.

4. Income Tax. 4.1. Parents own the business and the captive.

4.1.1. P.A.T.H. 4.1.1.1. Starting 2017 - $2.2 million. 4.1.1.2. Only 2% variance between business and captive ownership.

4.1.2. Captive exit strategies for parents’ future income. 4.1.3. PLR 201609008 – Jan. 15, 2016 – disqualified 12 out of 13 types of insurance.

4.2. Big DBPP. 4.3. Forget the deduction and use life insurance to create tax advantage income. 4.4. NNGs. 4.5. Deferred Sales Trust.™ 4.6. TelosCapitalFunds.com. 4.6.1. Buyer issues an installment note to the Seller in exchange for the business. 4.6.2. Telos Capital unconditionally guarantees the note payments to the seller. 4.6.3. Seller receives monthly payments over up to 50 years. 4.6.4. Telos reinvests the capital to get a return in excess of its obligation to seller. 4.6.5. Pasadena. 4.6.6. In CCA 20123401F the buyer’s LC were standby. 4.6.7. Stan Crow’s Monetized Installment Sale. 4.7. CRT if “C” corporation and to a stranger. 4.8. §453(e) if two years. 4.9. §7701(o) and Rev. & Tax. Code §19774.

4.9.1. 40% NEST penalty. 4.9.2. File an IRS Form 8275. 4.9.2. Opinion Letter.

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4.10. Moving. 4.10.1. Nevada, etc. 4.10.2. U.S.V.I. and Puerto Rico. 4.10.3. Expatriation.

5. Employee Benefits. 5.1. Defined benefit pension plan.

5.1.1. As part of the parents’ exit strategy. 5.1.2. Manipulating the value down. 5.1.3. Providing for a larger accumulation.

5.2. Pushing the limits. 5.2.1. Mere joint investment. 5.2.2. Investing in real property inside the retirement plan.

5.2.3. UBTI limits. 5.2.4. Prohibited transaction limits.

5.2.5. Plan asset rules. 5.5. IRAs. 5.5.1. Self-directed IRAs. 5.5.2. Lower audit profile. 5.5.3. Creditor protection issues. 5.5.3.1. Rollover vs. contributory. 5.5.3.2. State vs. Federal. 5.5.3.3. Participant vs. heir.

5.5.4. Problem with prohibited transactions. 5.5. Maintaining the parents on the health insurance plan.

6. Psychological Issues. 6.1. Getting the clients to dip their toes into the water. 6.2. Convincing the clients that they will remain in dictatorial control with irrevocable trusts. 6.2.1. Removing the trustee and naming a new one. 6.2.2. Assets aren’t in the trust. 6.2.3. Protectors.

7. Conclusions. 7.1. Timing, as with tax and assets protection planning, may be the most important factor. 7.2. Team effort by a unified group of advisors. 7.3. Use a calendar system. 7.4. Use a maintenance program.

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Moving Your Business To The Next Generation: Gift Tax; Estate Tax;

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Moving Your Business To The Next Generation: Gift Tax; Estate Tax;

Income Tax; Employee Benefit; And Psychological Issues March 3, 2016 Page 8 of 8