Posts Tagged ‘family business’

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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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Posted in Corporate Tax, Estate Tax, Family Tax Issues, Planning, Tax Strategies | No Comments »

An Easy Way For The Kids To Buy Their Parents’ Stock — Tax-Free

Tuesday, April 7th, 2009

Do you want to transfer your business to your kids? Read this:

Mom or Dad wants to transfer the family business to one or more of the children. But the money to fund the buyout at the death of the parent/stockholder —insurance on the parent’s life — is in the wrong place.

Here’s a foolproof way of getting the job done, according to an IRS letter ruling:

The father, Joe, worked with his son, Sam, in a business founded by Joe. The stock of the corporation was owned 25 percent by Joe, 4 percent by Sam and the balance by five other children not active in the business.

Joe had two main objectives: First, to have his stock go to Sam after his death and, second, to make sure that his wife, Mary, would be financially secure for the rest of her life.

Joe and his son developed a plan to accomplish these objectives. They entered into a buy-sell agreement requiring Sam to buy his father’s shares from his estate after his death at fair market value. To fund the purchase, Sam would use the proceeds of a life insurance policy on his dad’s life.

The corporation owned the insurance policy and paid the premiums. Joe intended to buy the policy from the corporation for its cash-surrender value and gift the policy to his son. From then on, Sam would pay all premiums. Great news!

The IRS ruled that, under these conditions, Sam could collect the insurance proceeds income tax-free (IRS Letter Ruling 8906034).

There are two more tax goodies that flow as a result of this ruling.

One, when Sam buys Joe’s stock from his estate, the sale of the stock by the estate is income tax-free.

Why? Under the tax law, the estate gets a new tax basis equal to the stock’s fair market value at the date of Joe’s death.

Two, since Mary is the beneficiary of Joe’s estate, there is no estate tax. Why? An estate is entitled to a 100 percent marital deduction for all property passing to a spouse, Mary in this case.

What could be better? No income tax. No estate tax.

Sam owns 100 percent of Joe’s stock.

Mary is financially secure.

Perfect!

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Posted in Estate Tax, Family Tax Issues, Insurance | No Comments »

A Review of Gift-Tax Rules to Enchance Your Family’s Wealth

Tuesday, April 7th, 2009

Applause! Applause!

Congress in 1998 buried an old and onerous gift-tax killer rule. Yet few people are aware of the tax-saving advantages of the new law.

First, some background. Gifts to your spouse are sheltered by an unlimited marital deduction, no matter how much the gift — during life or at death — there is no gift tax or estate tax. For lifetime gifts to all other individuals, the first $12,000 ($24,000 if married) is also exempt from tax.

A gift-tax return is generally not required for gifts qualifying for the marital deduction. On the other hand, a gift-tax return must be filed for all gifts in excess of $12,000 per donee (the person receiving the gift) per year.

Just like your income-tax return, your gift-tax return is due on April 15. For example, taxable gifts made in 2005 should have been reported on a gift-tax return filed by April 15, 2006. The IRS has three years from the date a gift-tax return is filed to make a gift-tax assessment. So, if the IRS decides four years down the road that a gift was worth more than the value shown on your timely filed gift-tax return, it’s out of luck. The IRS cannot assess any additional tax on the gift.

In the past, there was a catch.

Again, some background. The estate and gift taxes are unified so that a single graduated rate schedule applies to cumulative lifetime and death transfers. As a result, the final tax on your estate depends on the amount of taxable gifts made during your life.

The more lifetime taxable gifts, the higher your estate tax.

Sad but true, the courts allowed the IRS to revalue gifts — even after death — in order to determine the decedent’s estate tax. While it was too late to assess additional gift taxes on the gift (because the three-year time period had run out), the revalued gift could bump the estate into a higher tax bracket and cost — often huge — additional estate-tax dollars.

If the IRS claimed that a lifetime gift — very often the stock of a family business — was seriously undervalued, the tax on the estate would skyrocket. The estate had a tough time proving that a business valuation made years earlier (5, 10, 15 years or more) was and is still correct.

OK, let’s hear the drumroll for the new law:

For gifts made after Aug. 5, 1997, the IRS can no longer revalue lifetime gifts for estate-tax purposes. You must only jump through one hoop: report the gift on a gift-tax return. The value of the gift must be shown on the return or disclosed on the return or an attachment in a manner adequate to disclose to the IRS the nature of the gift.

After three years, the IRS (and you) are bound by the values shown on the return.

The door is, however, still open for the IRS to revalue some gifts:

• Any gift made prior to Aug. 6, 1997;

• A gift-tax return is filed, but the gifts are not properly disclosed or reported;

• Gifts not shown on a return;

• No gift tax return was filed because you thought the gift was worth $12,000 or less.

Here’s what to do for absolute protection:

Except for cash gifts under $12,000, report all gifts — particularly gifts involving the stock or an interest in any kind of family business or partnership — on a timely filed gift-tax return.

The more you are worth, the more your estate plan should include a well-thought-out lifetime plan, which includes a gifting program to the next generation.

Generally, cash gifts are a no-no. Leveraged gifts (usually involving a family limited partnership (FLIP), intentionally defective trust (IDT) or one or more of the dozens of life insurance strategies, are smart. They beat up the IRS legally and keep you in control of the gifted assets for as long as you live.

Gifting (using an FLIP, IDT or life insurance) is only one of 22 strategies used to legally avoid the estate tax. Learn how and when to use all the strategies —whether you are worth $2 million or $20 million.

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Posted in Estate Tax, Family Tax Issues, General Tax Strategies, Insurance | No Comments »

Don’t go overboard with one kind of tax strategy

Saturday, April 4th, 2009

Professionally, my second love is writing this column. My first love is consulting with the people who read it.

Every family I work with is different. So are their businesses, their situations, their problems. In spite of these differences, I’m rarely surprised by anything totally new. But one reader sent me something I had never seen before.

Here’s the story.

After about an hour on the phone discussing an estate plan, son Sam calling at the request of dad Joe agreed to send me some typical information: tax returns, financial statements and a copy of the existing plan. About one week later, a heavy box arrived with a five-inch stack of documents. About four inches worth were nine separate family limited partnerships. They were the same except each partnership owned a different asset: the family business, a residence, investments, etc.

As I thumbed through the papers, I couldn’t help thinking about the drunk who was told, “A shot of whiskey each day is good for you.” The guy who did Joe’s estate plan was clearly drunk on partnerships.

One thing should be made clear: I am an enthusiastic cheerleader for the use of limited partnerships in estate planning. Use ‘em all the time. But this overkill of a single strategy just didn’t do the best possible job.

Using the computations of the adviser, the IRS would get more than $2 million in estate taxes. Another $1.1 million of IRS enrichment was likely because of a gross misuse of the partnership strategy.

What does a family limited partnership accomplish? It allows you as a general partner to totally control the use of any asset transferred to the partnership yet reduce the value of the assets transferred. For example, $1 million of assets transferred to a partnership are usually worth only about $650,000 for tax purposes. That $350,000 discount in a 55 percentestate-tax bracket would reduce your estate-tax burden by $192,500. Not bad!

A familylimited partnership is also a great asset-protection strategy. Creditors can’t get at the assets in the partnership. Neither can divorcing spouses of your kids, who are usually the limited partners.

Used properly, a partnership is almost a perfect tax tool. In general, don’t use them to own the stock of your family business. Nor should one be used for non-income-producing personal assets, like a home or car. It’s a valuable strategy for almost every other asset you might own: publicly traded stocks and bonds, real estate, you name it.

Without covering every detail, we terminated the partnerships that held the family business and two family homes. The business elected S corporation status and was transferred to an intentionally defective trust, and the residences were transferred to qualified personal residence trusts. Those are similar concepts that allow you to heavily discount the value of the assets transferred to them.

We used the liquid assets in two other partnerships to pay the premiums on second-to-die life insurance on Joe and his wife, which was owned by an irrevocable life insurance trust that we created. That trust removes life insurance from the taxable estate of the husband and wife.

When all the smoke clears, Joe and his four children, including Sam, will be enriched $4 million to $7 million more than the original overkill plan, depending on how long Joe and his wife live.

One warning: This is an example of overindulgence in one tax strategy. Although the above descriptions cover the main points of how Joe’s problems were solved., this is not a do-it-yourself kit. There are a number of traps and exceptions. Only proceed with the help of an expert.

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Posted in General Tax Strategies, General Tax Talk, Uncategorized | No Comments »

A smart way to transfer your business

Friday, April 3rd, 2009

This article is about an old IRS letter ruling that is one of my favorites. It might be labeled “The lazy man’s way to plan your business transfer.“

The ruling shows you how to take advantage of some favorable tax law while avoiding pitfalls. Good stuff!

Well, there is one slight problem to using the technique: You must drop dead before your family can enjoy the benefits of Letter Ruling 9116031.

But wait, hold the phone. The ruling has one redeeming quality. Really!

First, the facts: Joe, his wife, Mary, and their children owned all the stock in a family business. Joe died in 1990 and Mary inherited all of his stock.

(Note: Mary’s tax basis — for computing capital gains — is the fair market value (FMV) of the stock on the day Joe died. For example, if the FMV was $1 million and she sold it for $1 million, there would be no capital gains tax.)

The fact that Joe’s tax basis, while he was alive, was $25,000, is immaterial. Mary immediately sold all of her stock back to the corporation.

Here’s the general rule: When you or any member of your family sells stock back to your corporation (called a redemption), the redemption is usually taxed as a dividend — a tax disaster.

But there is a special tax-saving exception for a family member who has owned the stock for 10 years or more: If he/she divests all interest in the company (including any position as an officer or director), the redemption is treated as a sale (gets favorable capital gains treatment, instead of being a dividend).

Since Mary sold all (stock she owned before Joe died and stock she inherited from him) of her interest in the corporation, the purchase by the corporation of her shares was considered a bona fide sale (redemption) and not a dividend — a big tax victory.

When all the smoke cleared, not only had Mary escaped a big dividend income tax bill, but she had succeeded in effectively transferring the business to her children. How? Since the kids now owned all the remaining issued and outstanding stock, they owned 100 percent of the business.

To sum up: Mary walked off with a near-tax-free capital gain, (the price paid to Mary for the stock was a bit more than the exact FMV of the stock inherited from Joe) while the kids walked off with the business.

A fantastic tax result.

Stop and think about your own business succession plan for a moment. Isn’t that the result you want — a fantastic tax-free (for income, gift and estate taxes) result? Yes, you can get that tax-free result every time.

More often than not, succession plans are implemented during life, which means there is a second issue (the first issue is tax-free): control.

The typical business owner wants control of his business for as long as he lives. So, when you sit down with your professional advisors, make sure you accomplish a perfect solution to the two key issues: (1) a tax-free transfer and (2) keeping control for as long as you live.

If any other result is offered (no matter how good or smart it sounds), get a second opinion.

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by Irv Blackman

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