Posts Tagged ‘business owner’

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Everything you should know about who should own business real estate

Saturday, May 30th, 2009

The first commandment of my someday-I-will-write-it bible of taxation would be “Thou shalt not put real estate into a corporation.”
We see it at least a dozen times year: When readers of this column ask us to do a tax consultation (usually for transfer/succession/estate planning), we find the business real estate in a separate C corporation (sometimes an S corporation) and leased to the operating corporation. Often, the real estate is owned by the operating corporation. Wrong! All are wrong. Actually a tax disaster waiting to happen. Why?
Someday, when you try to get the real estate (invariably, depreciated down to a low tax basis and appreciated in value) out of the corporation, you will run straight into a double tax. Again – why? Well, the first tax will hit the corporation when the real estate is sold (or transferred to the stockholders). Problem is, the sales proceeds are stuck inside the corporation and there are only two ways to get at those proceeds: via a dividend or a corporation liquidation. Sorry, both are subject to a second tax. A transfer of the property to the stockholders also triggers a double tax.
So what’s the answer?… Imagine a business owner (Joe) who is married to Mary. Joe should take title at the time the real estate is purchased and then lease it to his operating corporation. Here are some of the tax goodies that can come Joe’s way over time:
1. The rent Joe collects is not subject to social security tax (or other payroll taxes), nor does the rental income interfere with his social security benefits.

2. Joe can borrow (tax-free) against the property if he needs cash.

3. A sale of the property is subject to only one capital gains tax, which Joe can report on the installment method if he takes back a mortgage for a portion of the
purchase price. Joe might even exchange it tax-free for another piece of property (called a “1031 exchange”).

4. When Joe dies, his heirs get a raised basis, for example: Say Joe bought the property 25 years ago for $100,000, and it is now fully depreciated down to $20,000 (the cost of the land). The value of the property on his date of death is $620,000. Now get this – that built-in $600,000 of profit escapes income tax. Forever! And also this – Mary now owns the real estate (free of income and estate taxes) with a brand new tax basis of $620,000… Just as if she had bought the property for the $620,000 price. Yes, she can depreciate this property (except for the value of the land) using her new $620,000 tax basis, which will shelter her rental income.

5. The property can be put into a Family Limited Partnership (FLIP), which has many tax and non-tax benefits. For example, a $1 million piece of real estate transferred to a FLIP can receive a discount for estate tax purposes of about $350,000. The estate tax savings could be as high as $157,500 (using current estate tax rates)

And, oh yes, when Mary dies, the law allows her to repeat the raised-tax-basis trick (to raise the value of the property at her death) all over again when she leaves the property to the kids.
Now you know why owning real estate in a corporation is not only a tax trap, but it also prevents you from reaping a tax harvest during your life, at your death and beyond.
Want to learn more tax tricks that will save you a bundle?… take a peek at my website: www.taxsecretsofthewealthy.com. If you have a question call Irv (847-674-5295).

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Experience Has Taught Us how To Attract, Keep Great People

Saturday, April 18th, 2009

Our typical consulting assignment is to put together a wealth transfer plan for a successful business owner.

Invariably, the client brings up two critical and related operational problems: “How do I keep my top executives?” (The headhunters — usually working for a competitor — are always circling.) And “How do I attract new quality people?”

No, the problem is not new. It’s been a problem in the past and, more than likely, will get worse in the future as the bidding war for talented people escalates. What to do?

Almost 20 years ago, after struggling with the problem for about a year, we decided to develop an organized plan to find the answers. We interviewed our few client/owners who did not have the two problems; we also interviewed their key management people.

Then came the hard part: getting permission to interview the key people at clients that were suffering with the problem.

What quickly became clear was that almost 100 percent of the best key people had the soul of an entrepreneur. But for various reasons they did not want to strike our on their own or couldn’t (usually because they could not raise the required capital).

The answer turned out to be simple: “Mimic ownership” — give ‘em the same challenges as an owner and, if successful, most of the rewards.

Additional interviews just kept reconfirming the original answers. The top (non-owner) executives wanted four core benefits of ownership: (1) A piece of the action (a share of company profits); (2) get paid when they are sick or become disabled; (3) receive adequate retirement pay when its time to leave the company; (4) and a death benefit for their family (“Like my piece of the equity if I get hit by a bus” is the way most executives put it.)

Over the years we have created hundreds of contracts (the technical name is a nonqualified deferred compensation agreement; the non-technical name is a golden handcuff agreement) that attract and keep the kind of people you want in your organization.

Let’s take a closer look at each of the four desired benefits:

A piece of the action — Typically, this is a percentage of the yearly profits in excess of specific dollar amounts. Often, the percentage grows as the businessand profits grow.

For example, Sam Eager will get 3 percent of all before-tax profits in excess of $200,000 and up to $300,000; 5 percent from $300,000, to $400,000; and 8 percent over $400,000. Suppose the amount for a particular year is $24,000. Usually, Sam will get about one-third ($8,000) in cash and the balance ($16,000) is deferred.

The deferred portion is invested for Sam’s benefit. When does Sam get the deferred portion and the accumulated earnings on this portion (usually called the side fund)? When he becomes disabled, dies or reaches retirement age (the age is usually set around 58 for younger key employees and in the 65-age range for older key people).

When the key employee becomes entitled to collect the side fund (say it is $500,000), it usually is paid out in equal annual installments (say 10 years) or $50,000 per year plus the additional investment earnings for that year.

Disability — The employee gets paid when sick or disabled — whether for a day or for a lifetime. This benefit is covered by long-term disability insurance. It is essential that “disability” is defined “word for word” in your agreement the same as the word is defined in the disability insurance contract.

Retirement — The side fund (described above) supplements any regular retirement program (like a 401(k) or profit-sharing plan). Typically, the executive is allowed to direct the investment of the side fund, which remains an asset of the employer.

Following are the tax consequences of the arrangement: The side fund earnings are taxable to the employer. When the employee receives a distribution, the company gets a deduction for the exact amount distributed and the employee must report the identical amount as taxable income.

If the employee leaves for any reason-except because of disability, death or retirement-the entire side fund is forfeited by the employee and remains the property of the company. Hence, the name, “Golden handcuffs.”

A set amount of money at death — When an owner dies, the family can sell the business (assuming it is not transferred to the kids). A similar benefit (really a death benefit) should be given to the employee. Of course, this benefit should be insurance funded.

We have been doing these non-qualified plans for years. Done right, they work. Often, when an owner does not have a family member to pass the business to, the side fund serves as the down payment by one or more of the key people to buy the business from the owner.

Two warnings: (1) This article does not attempt to cover every detail and the endless variations for tailoring an agreement that is perfect for your company. Always work with an experienced advisor. Years of experience has proved that the right agreement will make your good people even better. (2) But sadly, there is no agreement we have ever seen that will make a bad employee even a little bit better.

In a way, this getting-and-keeping good people is a frustrating subject. The reason is that we have never been able to develop a cookie cutter solution. Yes, the four core benefits are almost always the same or similar.

—

Irv Blackman is a certified public accountant who lives part-time on Marco Island and specializes in estate planning, business succession and asset protection.

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Think Fast: What’s Your Business Worth?

Thursday, April 16th, 2009

Give the right answers and you can win big bucks on many TV game shows. Typically, the host only allows about 15 seconds for the contestant to give the right answer.

Okay, try this quick quiz: What is the most valuable asset you own? Hands down, almost every business owner answers, “My business.” Good! Next question … What’s your business worth? Silence! Yes, the final and most common answer is no answer — given 15 seconds or 15 months.

What happens in real life when those same business owners or their families must value the business? Stuff happens! Things like gifts of the family business stock to the kids; death (requiring valuation for estate tax purposes); or divorce (where valuation becomes an expensive legal battle).

Or, how about buying or selling a business? The wrong valuation can rob you and your family of hard-earned dollars. It can even cause your business to be sold to pay taxes.Here are three business valuation myths that I hear from business owners and their families when I consult with them. First, the business is worth book value (usually this value is too low); second, the value is eight to 10 times after-tax earnings (usually this value is too high); and third, an S corporation is worth more than a C corporation (a corporation that pays income tax) because an S corporation doesn’t pay income tax. (This is just plain wrong. There’s no difference in value.)

Visualize this: There are two piles of stock in front of you. One pile is made up of publicly traded stock, like Microsoft, IBM and Exxon Mobil Corp. with a total value of $4 million. The second pile is the stock of Your Family Business, Inc. (YFB, Inc.), also worth $4 million by the “right” (even the IRS would agree) valuation method. Think for a minute. Which pile is worth more? Right, the first pile: the publicly traded stock. Just call your broker and you can have the full $4 million in your bank account, less the broker’s commission, in a few days. What about the value of the second pile-YFB, Inc. stock? Well, the fact is that for tax purposes the courts give you a discount for general lack of marketability of about 35 percent, or about $1.4 million.

So, for tax purposes the stock of your $4 million family business is only worth $2.6 million. Surprise! Even the IRS has come around to agree with such discounts. The discount will, in this example, save your estate about $700,000 in estate taxes.

What is the most common reason for valuing a family business? Hands down, when dad (or mom or both) want to transfer the business to the kid(s). Now during dad’s life.

Dad usually has three basic requests: (1) “Make sure my lifestyle (and my spouse’s) can be maintained for life”; (2) “Want to control my business (and my other assets for as long as I live”; and (3) “Transfer my business to my kids tax-free (no income tax, capital gains tax or other taxes).”

Yes, all three basic requests are easy to accomplish if you employ the proper tax-strategies: The core strategies are (1) a well-done valuation (acceptable by the IRS), which is easy to do; (2) a recapitalization (creates voting and nonvoting stock); (3) use an intentionally defective trust (avoids all taxes on transfer of nonvoting stock to kids).

But we need some readers to volunteer their family businesses so we can structure a plan(s) and then write about them in future columns. Real names will be withheld. Don’t worry about your exact facts Maybe you have only one kid in the business; maybe two or more; maybe some in the business, some not; or maybe no kids in the business and you want to get the business to one (or more) employee(s) (and, of course, they have no money).

Just two ground rules: (1) You really want to transfer your business to your kids, other family members or employees (no hypotheticals) and (2) your business has a real fair market value of $3 million or more (your best guess of what a real buyer would pay). Just call me (Irv Blackman) at 239-417-9732 and let’s chat about your exact situation.

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The Best Way To Attract And Keep Great People

Tuesday, April 14th, 2009

Our typical consulting assignment is to put together a wealth transfer plan for a successful business owner. Invariably, the client brings up two critical and related operational problems: “How do I keep my top executives?” (The headhunters—usually working for a competitor—are always circling.) And “How do I attract new quality people?”

The problem is not new. It’s part of the past and, more than likely, will get worse in the future as the bidding war for talented people escalates. What to do?

Nearly 20 years ago, after struggling with the problem for about a year, we decided to develop an organized plan to find the answers. We interviewed our few client/owners who did not have the two problems; we also interviewed their key management people. Then came the hard part: getting permission to interview the key people at clients that were suffering with the problem.

What quickly became clear was that almost 100 percent of the best key people had the soul of an entrepreneur. But for various reasons they did not want to strike our on their own or couldn’t (usually because they could not raise the required capital).

The answer turned out to be simple: Mimic ownership. Give them the same challenges as an owner and, if successful, most of the rewards. Additional interviews just kept reconfirming the original answers.

The top (non-owner) executives wanted four core benefits of ownership: (1) A piece of the action (a share of company profits); (2) get paid when they are sick or become disabled; (3) receive adequate retirement pay when its time to leave the company; (4) and a death benefit for their family (“Like my piece of the equity if I get hit by a bus” is the way most executives put it).

Over the years we have created hundreds of contracts (the technical name is a nonqualified deferred compensation agreement; the non-technical name is a golden handcuff agreement) that attracts and keeps the kind of people you want in your organization.

Let’s take a closer look at each of the four desired benefits:

A piece of the action — Typically, this is a percentage of the yearly profits in excess of specific dollar amounts. Often, the percentage grows as the business and profits grow. For example, Sam Eager will get three percent of all before-tax profits in excess of $200,000 and up to $300,000; five percent from $300,000, to $400,000; and eight percent over $400,000. Suppose the amount for a particular year is $24,000. Usually, Sam will get about one-third ($8,000) in cash and the balance ($16,000) is deferred. The deferred portion is invested for Sam’s benefit. When does Sam get the deferred portion and the accumulated earnings on this portion (usually called the side fund)? When he becomes disabled, dies or reaches retirement age (the age is usually set around 58 for younger key employees and in the 65-age range for older key people). When the key employee becomes entitled to collect the side fund (say it is $500,000), it usually is paid out in equal annual installments (say 10 years) or $50,000 per year plus the additional investment earnings for that year.

Disability — The employee gets paid when sick or disabled — whether for a day or for a lifetime. This benefit is covered by long-term disability insurance. It’s essential that disability is defined word for word in your agreement the same as the word is defined in the disability insurance contract.

Retirement — The side fund (described in one above) supplements any regular retirement program (like a 401k or profit-sharing plan). Typically, the executive is allowed to direct the investment of the side-fund, which remains an asset of the employer. Following are the tax consequences of the arrangement: The side-fund earnings are taxable to the employer. When the employee receives a distribution, the company gets a deduction for the exact amount distributed and the employee must report the identical amount as taxable income. If the employee leaves for any reason — except because of disability, death or retirement — the entire side fund is forfeited by the employee and remains the property of the company. Hence, the name, golden handcuffs.

A set amount of money at death — When an owner dies, the family can sell the business (assuming it is not transferred to the kids). A similar benefit (really a death benefit) should be given to the employee. Of course, this benefit should be insurance funded.

We have been doing these non-qualified plans for years. Done right, they work. Often, when an owner does not have a family member to pass the business to, the side fund serves as the down payment by one or more of the key people to buy the business from the owner.

Two warnings: This article does not attempt to cover every detail and the endless variations for tailoring an agreement that is perfect for your company. Always, and we mean always work with an experienced advisor. Years of experience has proved that the right agreement will make your good people even better. But sadly, there is no agreement we have ever seen that will make a bad employee even a little bit better.

In a way this getting-and-keeping good people is a frustrating subject. The reason is that we have never been able to develop a cookie cutter solution. Yes, the four core benefits are almost always the same or similar. But the bells, whistles and unique requirements of each situation makes it impossible to write a complete report — much less a book — on the subject. But if you have a question call Irv Blackman at 239-417-9732. Let’s chat about your specific key employee situation and how to keep ’em.

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Yes, You Can Avoid Estate Tax Legally

Tuesday, April 14th, 2009

Almost every reader of this column who calls me asks this question: “Irv, can you help me avoid (or beat, or kill, or finesse) the estate tax?” Often, an obscenity or two concerning how the caller feels about the estate tax is tossed into the conversation.

If you are worth about $6 million (or less) the answer to the question is almost always ‘Yes’; worth more, usually, ‘No.’ Let’s talk real numbers. Joe is worth $10 million and Jack is worth $20 million. Both are married. Joe’s estate tax damage (using 2011 rates) would be about $4 million; Jack’s, a tragic $9.5 million.

The higher your wealth, the less chance you have for killing the estate tax. Ah, but we can always — yes, always — entirely avoid the impact of the estate tax. For example, if you are worth $8 million, we know how to get the full $8 million (all taxes paid in full) to your family; worth $80 million, the entire $80 million to your family. Yes, it can always be done, whether you’re single or married, young or old, and even insurable or uninsurable.

Let’s play the game together. Substitute your own numbers into the little example that follows: Suppose you are worth $12 million and married. Subtract $2 million ($1 million if single), which leaves $10 million; then 50 percent times $10 million gives you your bitter estate tax bite; add 55 percent for your worth in excess of the $10 million.

Now, here’s the secret for legally avoiding the estate tax: create tax-free wealth. There are two ways: charity and life insurance. Both, if you do it right, put you in a tax-free environment.

Here’s a real-life story of Joe, a 63-year old business owner from Nebraska and married to Mary, age 62. Joe and Mary are worth $23 million. Using our little example above, the estate tax monster would eat $11.05 million of their wealth.

We designed a comprehensive and coordinated succession and estate plan for Joe and Mary that included four significant strategies: An intentionally defective trust to transfer Joe’s business to his kids tax-free; A family limited partnership for their investment assets (a stock and bond portfolio and real estate) and two different life insurance strategies, which are described below.

A side note before continuing: Every case is different. Different people, businesses, situations and facts. A big factor for Joe and Mary was their health: excellent for their age. So insurance went front and center.

So Joe has $.7 million in his company’s 401(k) and $1.4 million in various IRAs, which we transferred into the 401(k) a tax-free transfer. Then, we used a strategy called “retirement plan rescue” (RPR) — for the 401(k) — that purchased $6.5 million of second-to-die life insurance on Joe and Mary. Because of double taxation — first income tax and then estate tax —the $2.1 million in the 401(k) (without the RPR) would only net about $.6 million to Joe’s heirs. Sorry, but the tax collector would get the rest: $1.5 million.

The RPR allows the entire $6.5 million of life insurance to go to Joe’s and Mary’s heirs tax-free. In effect, we turned $.6 million into $6.5 million. Good for the kids, bad for the IRS. Neat!

One more point: We showed Joe how to invest his $2.1 million funds in his 401(k) in TIPs (“transfer insurance policies,” a form of senior settlements). TIPs currently earns 15.82 percent on average per year, without “Wall Street” risk. TIPs are the brainchild of a public company (sells on the NASDAQ). Joe’s prior investments were averaging a seven percent annual return with stocks, bonds and mutual funds.

Another strategy: Joe and Mary needed an additional $5 million of life insurance. At their age (if you don’t use a RPR) the premiums are normally very expensive. We used a strategy called “premium financing” (PF) to buy $5 million of life insurance on Joe’s life. PF allows you to buy life insurance without paying your premiums in cash. Instead, premiums are paid by having a trust you create pay each premium by the trustee signing a note to the lending bank.

Interest is added to the loan. All premium loans, plus accrued interest, will be paid out of the death benefits when Joe dies. The only costs paid by Joe are to the banks for initiating and maintaining the loan: about $60,000 paid the first year and an additional $180,000, which is paid in small amounts each year to age 100. Really an economic homerun: getting $5 million tax-free to Joe and Mary’s heirs for a small out-of-pocket cost of $240,000 (or less), which is paid over about a 30-year period. No question about it, PF is the most inexpensive way to buy life insurance (whether you buy $5 million, $10 million or more). You must qualify to use PF by being credit worthy and worth a minimum of $5 million.

These subjects — RPR, TIPs and PF — always create a blizzard of questions. So, if you would like to get more information about a RPR fax me your birthday and your spouse’s (if married). Also the total value of all of your qualified plans: 401(k), IRAs, etc. (total should be $200,000 or more). Write “RPR” at the top of the page.

Interested in premium financing? Fax me birthdays for you and your spouse and your net worth (must be at least $5 million, more is better). Write “Premium Financing” at the top of the page.

Interested in earning 15.82 percent on average per year? Fax me the estimated amount you may invest ($50,000 minimum). You must be an accredited investor. Write “TIPs” at the top of the page.

Please fax all inquiries to Irv Blackman at 847-674-5299: Include your name, your company name, home or business address, e-mail address and all phone numbers where you can be reached (home, business and cell) and all additional info requested above for your area of interest.

Finally, if you want to know how to create your own business succession plan and/or estate plan that totally conquers the estate tax, check out one of my web sites:

www.taxsecretsofthewealthy.com

Irv Blackman is a certified public accountant who lives part-time on Marco Island and specializes in estate planning, business succession and asset protection.

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