Protecting and Transferring the Family Jewels

Brian T. Whitlock, CPA, JD, LLM

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Overview

• Identify your Risks Business Risks Personal Risks

• Protect Yourself and Your Loved Ones

• Minimize Taxes and Administration Expenses• Transfer your Business• Transfer Financial Assets

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• Employee Theft• Customer Theft • Fire or Business interruption• Economic Risk

Identify your Business Risks

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• Economic Risk • Diversification of Investments

• Diversification of Operations(Wholesale, Retail, Pawn, Service, Repair)

• Employee Theft• Opportunity• Incentive

(Alcohol/Drugs, Infidelity, Gambling, Medical)

• Rationalization

Protection from Business Risk

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• Business Insurance• Theft• Flood & Fire - Business Interruption• Key Person Life/Disability Insurance • Workman’s Compensation Insurance

Protection from Business Risk

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• Shield from Business Liability (Creditors)• Sole Proprietorship and General Partners

• All Personal Assets exposed• No shield or limit on liability

• Limited Partnership• Only General Partner exposed• Silent partners losses are limit to assets inside Limited Partnership

• Corporation vs. Limited Liability Company• Must respect formalities of entity• Liability limited to assets inside corporation• Beware of Personal Guarantees

Protection from Business Risk

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• Priority of Creditors• Secured

• (Mortgage against Real Estate)• (UCC against assets)

• IRS and State Department of Revenue •(Trust fund liability for payroll taxes and sales taxes)

• Personal Guarantee• Unsecured Creditors

Protection from Business Risk

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• Property and Casualty• Auto

• Fire

• Slander/Libel

• Personal • Medical Health

• Death

• Disability

• Divorce

Identify your Personal Risks

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• Insurance• Personal (Health, Disability, Life, Long Term Care)

• Property (Auto, Home, Umbrella)

• Statutorily Protected Assets• Homestead Property (e.g., Florida, Texas)

• Tenants by the Entirety

• Qualified Plans (pension, IRA, ROTH IRA, etc.)

• Annuities and Life Insurance

Personal Asset Protection

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• “They can’t take what you don’t have”• When is it too late to transfer?

• Preferential payments in Bankruptcy can be unwound• State Law – Generally transfers within 180 days• Clawback provisions (“Madoff”)• Courts can unwind transfers made to “Defraud Creditors”

• Before there is a problem• Estate Planning Reasons

Personal Asset Protection

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2010 Tax Relief Act – Transfer Tax Highlights

Tax Relief, Unemployment Insurance Reauthorization and Job Creation Act of 2010 (P.L. 111-312)

Signed by President Obama on December 17, 2010 Changes options for deaths occurring in 2010 Reunifies the estate and gift tax credit beginning in 2011 $5 million exemption for deaths occurring in 2011 and 2012 Indexes Gift, Estate and GST exemptions for inflation after 2011 Sets top estate and gift tax rate at 35% (2010 through 2012) Sunset - January 1, 2013

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Unused Credit of Spouse is “Portable”

Timely Election required

“A deceased spousal unused exclusion amount may not be taken into account by a surviving spouse… unless the executor of the estate of the deceased spouse files an estate tax return on which such amount is computed and makes an election on such return that such amount may be so taken into account”.

Return must be filed at the time prescribed by law (including extensions).

The election, once made, shall be irrevocable. If multiple spouses, credit limited to lesser of $5 million or

unused credit of last spouse to die regardless of election QUERY: What happens after Sunset?QUERY: What happens after Sunset?

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Planning Recommendations

Revise Wills and Trusts Not Mandatory (traditional A-B works under new law)

—Separate trusts may be beneficial for GST

Watch out for State Tax exemptions, decoupled states

Use it or Lose it $5 Million Credit equivalent for 2011 and 2012 May not be extended Keys: Choose assets wisely

—use High basis assets—Gift most likely to appreciate—Transfer value Keep Control

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The Family Safety Net (Things you MUST DO)

Revocable Living Trusts Minimize the Exposure to Probate Maximize use of $5 million Credit Shelter at Death

—Separate Trusts in Common Law States will work better— Single Trust can work in Community Property States

Pour-Over Wills Probate May be Necessary or Advisable

Durable Power of Attorney for Health Care Durable Power of Attorney for Property (Possible abuse?)

Irrevocable Life Insurance Trust Protect Life Insurance Proceeds from Death Tax

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Irrevocable Life Insurance Trust

Ironies of Insurance Large Dollar Value at Death Small Value During Life

Death Benefit is Income Tax Free Death Benefit is Estate Tax Free

Without “incidents of ownership”

Clifford Crummey Keeps Control Use of Trust to keep Control Problem: Only “Present interest” Gifts count for tax-free $13,000 gifts

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Remember

“You Ain’t Dead Yet!”Irving L. Blackman CPA, JD

What are your Objectives? (Things you Might Do)

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Transferring your Business“What are your Objectives?”

Secure Stream of Income For Life For Life of Spouse/Life Partner

Transfer of Business To Family Member To Business Partner or Key Employee To Unrelated Third Party

Minimize Taxes

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Transferring the Business

Tax Considerations (Multiple Taxes) Payroll Taxes (FICA, FUTA, SUTA) Corporation Income Taxes

—C Corporation (15% on first $50,000, top rate 35%)—S Corporation (avoid double tax)

Individual Income Taxes—Ordinary (top bracket 35%)—Capital Gains (15%)

Gift & Estate Tax

Who’s the buyer/transferee Family or Third Party

What do you “Want” to get out of any transfer?

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Buyer/ TransfereeDividend Rec’d

- Interest Expense- Income Tax

Net Cash available to service debt

Seller/ Transferor

Interest Income less ordinary TaxPrincipal less LTGC tax

Net Cash to live on

Infernal Revenue ServiceTriple Winner

Sale by a “C” Corporation – Most Tax Inefficient

KEY: Limit the Taxes by limiting the number of Taxable Transfers

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Create a Tax Efficient Stream of Income

Salary and Fringe Benefits Linked to Financial Health of Business Linked to Physical Health of Owner

—Must be reasonable compensation to be deductible

Distributions from Business Rents

—Separate if Building outside of Entity— If Business failed Building could be rented/sold to others

Flow through Entities (Partnership/LLC/S Corp)—Linked to Financial Health of Business—Not Linked to Physical Health of Owner—Discourages Transfer of Equity Ownership

KEY: Create an Income Tax Efficient Business Environment

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Create a Tax Efficient Stream of Income

Qualified Deferred Compensation Plans Pension/Profit Sharing/SIMPLE/SEP Tax deductible & Income to employee deferred

—Must not discriminate

Non-Qualified Deferred Compensation—Discrimination is permitted

Top Hat Plan Death Benefit Plan Flow through Entities (Partnership/LLC/S Corp)

—Linked to Financial Health of Business—Not Linked to Physical Health of Owner—Discourages Transfer of Equity Ownership

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Unfunded Non Qualified Deferred Compensation

Design Variables for Non-Qualified Deferred Compensation Age of Beneficiaries Amount and Number of Payments Interest Rate

Tax Characteristics of Payments Estate Taxes

—Only Payments required after Death will be an Estate Asset

Income Taxes—Deductible to Business and Taxable to Employee— Income in Respect of a Decedent, if payments survive death

Type of Compensation Impacts FICA and MHIT Taxes—Past Services – Taxable when paid—Present and Future Services – Taxable when earned and vested

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Case Study

Joe (63) and Marie (61) wish to receive $100,000 per year for life. Payments will begin on January 1st following Joe’s 66 birthday.

Calculate Joe and Marie’s joint life expectancy Calculate the present value of the annuity payable over life

expectancy Amortize the liability over the three years until Joe’s retirement Add the liability to FICA and Medicare wages, if earned and

vested, for W-2 purposes Withhold Pay FICA and MHIT tax on the annual liability, with

the 4th Quarter Payroll Tax

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Case Study Solution

Life Expectancy for Joe (63) and Marie (61) 2000 Census

— Median until second death 25.9

Select Interest Rate Long Term AFR (4.09% Quarterly) Section 7520 Rate (February 2011 2.8%)

Calculate present value of annuity beginning in 3 years 23 years of payments of $100,000 at 2.8% $1,714,889 Present Value today $1,587,793

Amortize Liability over 3 years Interest is $127,096 (difference between $1,714,889 and $1,587,793)

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Death Benefit Only Plans

Income Tax Deductible to Business But Taxable to Recipient = Neutral

—Caveat - Reasonable Compensation Test

Payroll Taxes Past Service and Salary History is Test

—Not subject to payroll taxes since paid after death

Gift and Estate Taxes Liability reduces the Liquidation Value & Adjusted Book Value Benefit is excludable from the Taxable Estate of the Employee

—Provided employee has not retained right to change beneficiary—Best to pay as a benefit to second generation than spouse

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Keys to Transfer of Business Interest

Understanding Valuation of Closely-held Businesses Liquidation Value (the “Floor”) Income Methods

— Multiple of projected income— Discounted Future Cash flows— Increasing expenses (NQDC) reduces value

Adjusted Book Value— Market Value of Assets – Liabilities = Net Worth— Increasing Liabilities (NQDC) reduces value

Valuation Discounts Lack of Marketability

— Fractional Interests inhibit value

Lack of Management or Voting Control — Non-voting stock and limited partnership interests limit value

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Transfers to Third Parties

Increase Expenses – Decrease Value—Useful for Transfers to Family Members

Decrease Expenses – Increase Value Make sure Compensation reflects Market value Make sure Rents are at Market value

—Useful for Transfer to Third Parities

Convert from C Corporation to S Corporation Maximize access to Cash flow in Mature Business Eliminate Double Tax on Sale of Assets

KEY: Manage Finances in order to Impact Value

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Sale of Assets – What does the Seller Own ?

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Transferring Financial Assets - Beyond the Basics

Maximize Exclusions Lifetime Gifts ($5 – 10 Million currently) Annual Exclusions ($13,000/person/year)

Minimize Income and Estate Tax on Transfers—Leverage off of existing Cash Flows —Minimize Valuation by using today’s interest rates

Create an Income Tax Neutral Environment Intentionally Defective Income Only Trusts (IDIOTs)

Asset Protection – Trusts for others Control & Access Protect Family Members Keep Potential Creditors Away “They can’t take what you never had”

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Key Strategies for Family Transfers

Non Taxable Transfer - Gift to Trusts Spouse as Trustee = “Control” Spouse as Beneficiary = “Access”

Focus on Asset Protection Planning for Donees Keep the Creditors away

—Spendthrift Clauses—Layered Trustees—Power to Sprinkle or Spray of Income and or Principal

Maximize Flexibility by “Working with IDIOTs” Retain power to borrow cash or substitute assets Spouse as Trustee Spouse as Sprinkle or Spray beneficiary Trust Protectors

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Grantor Trust AAA Received

- No Income Tax100% available to service

debt

Seller/ Transferor

Interest + Principal (no tax)Income tax on S Corp Income Net Cash to live on

Infernal Revenue ServiceIncome Tax on S Corp Income Only

Leveraged Transfer to Grantor Type Trust

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Questions

Brian T. Whitlock, CPA, JD, LLM

Blackman Kallick, LLP10 S. Riverside Plaza – 9th Floor

Chicago, IL 60606

Phone (312) 207-1040

E-mail: bwhitlock@blackmankallick.com

Linked-in

Twitter: @TaxGems

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