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Planning for the Business Owner
Presented by Mark Sweeney
Agent, New York Life Insurance Company8075 Leesburg Pike, Suite 200Vienna, VA [email protected]
Registered Representative offering securities through NYLIFE Securities LLC, Member FINRA/SIPC, A Licensed Insurance Agency
8075 Leesburg Pike, Suite 200Vienna, VA 22182
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DisclaimerThis material is for informational purposes only and includes a discussion of one or more tax-related topics prepared to assist in the promotion or marketing of the transactions or matters addressed. It represents New York Life’s understanding of generally applicable rules. It is not intended (and cannot be used by any taxpayer) for the purpose of avoiding any IRS penalties that may be imposed upon the taxpayer. Taxpayers should always seek and rely on the advice of their own independent tax professionals.
New York Life Insurance Company, its agents and employees may not provide legal, tax or accounting advice. and none is intended nor should be implied from the following comments and observations. Everyone should seek the counsel of their personal tax and legal advisors who must form their own independent opinions on these matters based upon their independent knowledge and research.
Bates 497203 (exp. 7/31/2017)3
Planning for the Business Owner
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Team Planning Approach
Executive Benefits
Business OwnersGoals
Key Employee
Issues
Business Continuation Buy-Sell
Issues
Team Planning Approach
• BUSINESS PLANNING TEAM• Include other financial professionals
– Multi-disciplined approach– Fewer surprises– More thorough planning– All on same team
• Team members?
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Planning for the Business Owner
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Accounting Professional
Financial Planner
Business Appraisal
Expert
AttorneyLife
Insurance Professional
ClientDecision
Maker
Business Owner’s Goals
• Goals—Simple & Similar– Make money– Grow the business– Continue beyond the first generation
• How many actually succeed?*– 33% to 2nd generation– 10%-15% to 3rd generation
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* Source: Molly, V., Laveren, E., and Deloof, M. (2010) Family Business Succession and Its Impact on Financial Structure and Performance. Family Business Review, Vol 23 (2) 131-147.
Why Do Successful Businesses Not Survive? • Improper or no succession planning• Open issues at death/disability of the owner• Options
– Sell the business?To whom?How will this impact the family?
– Retain the business in the family?Who can run it?How will this impact inactive owners?Can the business survive the transition?
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Conflicts Between Heirs & Surviving Owners
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• Top $ for business interest or continuing income• A business value set for
estate tax purposes• Prompt payment for the
business• To be sure their interests are
protected• Little or no business risk
Heirs want…• To pay the minimum• Prompt transfer of business• Full control of business• To grow the business• Retention of customers
and employees
Surviving owners want…
Who Should Succeed You?
• Family• Co-owners• Key Employee• Outside third party• Liquidation
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Why Start Succession Planning Now?
• Protect family’s security• Establish a successor• Establish an estate tax value• Ensure prompt transfer• Minimize conflicts• Prepare business for sale
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Buy-Sell Arrangements: Types of Entities• The choice of buy-sell arrangement in part depends on the
type of business entity– C Corporation– S Corporation– Partnership– Limited Liability Company (LLC)
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Types of Buy-Sell Arrangements
• Cross-Purchase Method• Entity/Stock Redemption Method• Hybrid/Wait-and-See Buy-Sell
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Cross-Purchase Method
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Shares
Agreement between shareholdersto buy each other’s shares at deathStockholder
A 50%Stockholder
B50%
Cash
SharesSurviving Spouse or Executor
Cross-Purchase Arrangement Pros & Cons• Pros
– Step-up in basis– No attribution problems
• Cons from use of life insurance– Numerous policies– Potential transfer for value issues
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Entity/Stock Redemption Method
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Shares
Stockholder A 50%
Surviving Spouse or Executor
Stockholder B
50%
Agreement among shareholders and business
$$ for Ownership
InterestOwnership Interest
Business
Entity/Stock Redemption Pros & Cons
• Pros– Easy to understand– Fewer policies needed
• Cons– Family attribution rules– Can affect control– State minimum capital rules– Limited step-up in basis
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Hybrid Wait-and-See Method
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Stockholder A 50%
Stockholder B
50%
Agreement between shareholders and corporation
Business
Hybrid/Wait-and-See Pros & Cons
• Pros– Interest purchased by corporation or surviving stockholders– Provides flexibility– Can delay decision
• Cons– More complex agreement
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What’s the Right Buy-Sell for Your Business?• It depends!
– What is the business form?– Are owners related? – Will sale be during life or death?– Will the successors sell?
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Valuing a Business
• Why? – Best to determine before the event– Estate tax value– Related parties– Proper valuation critical
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Valuing a Business
• Valuation methodologies used in buy-sell agreements– Book value– Appraisal– Agreed-to value
• Work with a professional
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Funding a Buy-Sell Agreement
• Ways to fund a buy-sell:– Existing cash flow– Sinking fund– Installment payments– Bank loan– Life insurance
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Problem Solver!
• Properly drafted and funded buy-sell agreement– Risks:
UncertaintyBusiness could end
– Advantages:Establishes estate tax valueProvides prompt settlementPrompts transferAddresses all parties’ concerns
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Potential Key Employee Issues
• Issues involved:– Loss of confidence with customers & suppliers– Weaken credit rating– Co-employee morale– Expensive to hire and train replacement
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Why Do Key Employees Leave?
• Disability• Death• Voluntary exits
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Protection Against Loss of a Key Employee• Disability insurance• Key employee life insurance
– Asset of company– Income tax-free death benefit
• Encourage retention
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Retaining Key Employees
• Qualified Retirement Plans– 401(k)s, pensions, profit-sharing, etc.
• Non-Qualified Deferred Compensation• Endorsement Split Dollar• §162 Executive Bonus
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Non-Qualified Deferred Compensation (NQDC)
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• Purposes:– Reward executives– Incentivize executives– Attract talent
Non-Qualified Deferred Compensation
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EmployerKey
Executive
Written Agreement
Employer agrees to pay certain benefits upon stipulated contingencies
Key Executive agrees to provide services in
exchange for future benefits
Supplemental Executive Retirement Plan (SERP)
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• Non-qualified plan– Unfunded promise to pay benefits– Specified amount and time
• Taxation of benefits– Taxable to employee upon receipt– Deductible to company when paid
• Subject to IRC §409A
Non-Qualified Deferred Compensation Funding
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• Cannot be formally funded• Informal funding options:– Cash flow– Borrow– Pre-funding
Informal Funding with Life Insurance
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InsuranceCompany
Employee(or Heirs)
BusinessPremiums
Cash value or net death benefit to pay benefits*
Benefits at retirement and/or death
* Loans and withdrawals reduce any available policy cash value. In addition, loans against a policy accrue interest at the current rate and decrease the death benefit by the amount of the outstanding loan and interest.
Endorsement Split Dollar for the Employer• Freedom to choose who receives the benefit• Cost recovery• Control cash value• Reward loyalty
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Endorsement Split Dollar for the Executive• Provides personal life insurance protection at minimal cost to
the key employee• Individually tailored• Tax-free death benefit
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Endorsement Split Dollar
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Employee’sBeneficiary
Business
This example is hypothetical and intended for illustrative purposes only. It is not indicative of the actual performance of any particular product.
Key Employee
Endorses death benefit to the key employee
Names beneficiary Pays income tax on economic benefit to IRS annually
Owns the policy; pays the premium
At key employee’s death,recovers greater of cash value or premiums paid Insurance
Company Receives income tax-free death benefit
Section 162 Executive Bonus
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Premium included in executive’staxable income
InsuranceCompany
Executive’sBeneficiary
Receives income tax-free death benefit
ExecutiveOwns policyNames beneficiariesPays income tax on premium
Pays death benefit
Insurance companyissues policy to executive as owner
Pays Premiums
EmployerPays premiumDeducts as business expense
Comparison
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SERP Endorsement Split Dollar §162 Executive Bonus
Deductible by company whenpaid to executive
Non-deductible by company Deductible to company when premium is paid
Benefit taxed to executive when received
Executive taxed on economic benefit
Bonus taxed to executive when premium is paid
Insurance owned by company Insurance owned by company Insurance owned by executive
Company may access cash value
Company may access cash value
Executive may access cash value
Complex: Written agreement, reporting requirements, compliance with §§409A, 101(j)
Moderate: Written agreement, compliance with §101(j), no reporting
Simple: No agreement unless it’s a “restricted plan;” no reporting
Next Steps
• Get started!– Assess where you are– Work with your team
Create a customized plan– The “Team”
YouYour legal, accounting and other advisorsMy planning team
– Review your plan regularly
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Thank you
