Keeping It In The Family Resnick Associates

Resnick Associates

NEW YORK STATE CONCRETE MASONRY

ASSOCIATION

November 7, 2008Turning Stone Casino

Verona, NY

Resnick Associates

CONTACT INFORMATION

Terrance K. Resnick

Resnick Associates

2073 Doral Drive

Harrisburg, PA 17112

(717) 652-2929

(717) 540-5735 fax

[email protected]

Resnick Associates

Resnick Associates

1. Second Generation Firm – 40+ Years

2. Clientele throughout the United States

3. Extensive involvement with commercial and residential construction business owners

4. Business Trade Associations and Buying Groups

5. Published nationally and regionally

6. Featured in book Streetwise Marketing Plan

Resnick Associates

SMOOTH SUCCESSION: AVOIDING COMMON TAX AND ESTATE PLANNING

MISTAKES

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Important Questions to Ask Yourself

1. Are you working most your life to build your business only to see it eventually lost?

2. Are you aware that approximately 50% of the hours that you’ve worked were put in simply to pay a tax?

3. Are you putting your family in the eventual position

of no longer being on speaking terms?

4. Will your family maintain a healthy revenue flow when you are gone?

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Why Do Businesses Fail?• Mismanagement?

• Poor Investments?

• Inefficient Succession/Estate Planning?

WHICH IS THE LEADING CAUSE????

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The Answer Is……

INEFFICIENT

SUCCESSION/ESTATE PLANNING!

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2 OUT OF EVERY 3 FAMILY BUSINESSES DO NOT MAKE IT FROM THE FOUNDER TO

THE 2ND GENERATION!

• Original Owner Can’t “Let Go”

• Lack of Plan or Inadequate Planning

• The Next Generation is Ill Prepared

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IMPORTANCE OF SEPARATING COMPANY

FROM FAMILY• Challenge for Parents: COMMUNICATION

• Family Meetings / Business Meetings

• Board of Directors to Maintain Objectivity

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BUSINESS SUCCESSIONPLANNING CHECKLIST

Have These Issues Been Addressed?

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Issue #1

Define Personal Goals and Vision for the Transfer of Ownership and Management

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Issue #2

Identify Your Successor

If you are a Family Business, is a Family Member the best choice to take over?

Typically the answer is “Yes”, but it should not be automatic – the business must be run as a business first!

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Issue #3

The Importance / Unimportance of Family Involvement in Leadership and Ownership of the Company going Forward

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Issue #4

Techniques to Reduce or

Eliminate Estate Taxes

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Issue #5

Liquidity Positioning to Avoid the Forced Sale of the Company and Provide for Estate Equalization

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Issue #6

Buy-Sell Agreements

A. Stock Redemption

B. Cross Purchase

C. Wait and See

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Issue #7

Contingency Plan in the Event of Disability

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Issue #8

Stock-Transfer Techniques to Help Achieve Succession Goals

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Issue #9

Dependency on Business to Meet Retirement Cash Flow Needs

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Issue #10

Business Valuation

Is Succession to Family Members

or Outsiders?

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Some Leading Causes for Unsuccessful Succession

• No Succession Plan in Place• Unable to Retain Key Execs/Personnel after owner

exits the business• Insufficient Personal Estate Plan – Company left

to Inactive Spouse and/or family members• All siblings (whether active or not) having

ownership in the Company

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Coordinating Estate Planning with Succession Planning

• Many Business owners do either/or

• Business is generally the largest asset in the estate of the Business Owner – how does that effect the family and business?

• Limiting Taxes / Transfer Costs

• Providing Liquidity

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The Economic Growth and Tax Relief Reconciliation Act of 2001

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An Inside Look• Estate Tax

– Reductions Began 1/1/02– Top Marginal Rate Reduced to 50%– Repealed 5% Surtax– Top Rate Decreases 1% per year, Levels at 45%

in 2007-2009• After 12/31/09, Top Gift Tax Rate is top

individual income tax rate (no repeal of Gift Tax)• Year 2010 - FEDERAL ESTATE TAX

REPEALED

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THE FACTS OF “REPEAL”

After the 1 Year “Repeal” in 2010, the

Federal Estate Tax Law reverts to 2001 law:

$1,000,000 Gift Tax Exemption

$1,000,000 Estate Tax Exemption

55% Marginal Bracket ($3,000,000 to $10,000,000)

5% Surtax ($10,000,000 to $21,040,000)

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Common Goals

• Certainty of Distributions

• Reduce or Eliminate Estate Taxes

• Provide Liquidity – VERY IMPORTANT

• Ensure all Children are Treated Fairly

• Provide for Care of Minors & Disabled

• Preserve Family Business for the Family

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Common Mistakes

• Unrecognized Estate Size or Tax Bite

• Lack of Liquidity – VERY IMPORTANT

• Artificially Low Value on Company

• Reliance on Expensive Post Mortem

Planning

• Improperly Arranged Life Insurance

• Lack of Master Game Plan

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Common Mistakes (Con’t.)

• Failure to use IRS “Gifts”

• Leave Everything to Spouse

• Improper Use of Jointly Held Property

• Everything Owned by One Spouse

• Will Errors

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Revocable or Irrevocable Trust?

Depends on the Planning Purpose

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Estate Analysis

Have

Want

Current Plan

?

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Property in Your Gross Estate

Cash Investments

Real Estate Tangible Assets

Personal Property Revocable Trusts

Retirement Plans Annuities

Business Interests Life Insurance

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Annual Exclusion

• Gifts of up to $12,000 per Year

• Present Interest

• No Tax, No Paperwork

• Joint Gift; $24,000

...Husband and Wife

• College and Medical Expenses Unlimited

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Unlimited Marital Deduction

• Dollar for Dollar Deduction on Assets

Transferred to a Spouse

• Outright, Unconditional Transfer or

• Qualifying Trust (GPA or Q-TIP)

...Included in Spouse’s Estate at Death

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I Love You Will

Entire Estate is Left to Surviving

Spouse

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I Love You WillTax Analysis

Husband WifeTentative Taxable Estate $5,000,000 * $5,500,000

Marital Deduction $5,000,000 $ 0

Taxable Estate $ 0 $5,500,000

Tentative Estate Tax $ 0 $2,460,800

Applicable Credit Amt. $ 0 $ 345,800

Estate Tax Due $ 0 $2,115,000

Total Tax Paid: $2,115,000 *Assumes Assets Appreciate 10%

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Problems withI Love You Will Plans

• No Use of Applicable Exclusion Amount

in First Estate

…Failure to Use IRS “Gifts”

• Appreciation of Assets in Second Estate

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I Love You WillTax Analysis

Husband WifeTentative Taxable Estate $5,000,000 * $5,500,000

Marital Deduction $5,000,000 $ 0

Taxable Estate $ 0 $5,500,000

Tentative Estate Tax $ 0 $2,460,800

Applicable Credit Amt. $ 0 $ 345,800

Estate Tax Due $ 0 $2,115,000

Total Tax Paid: $2,115,000 *Assumes Assets Appreciate 10%

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Exemption Shelter Plan

ESTATE

$1,000,000Everything

Else

Income Spouse

Children

Principal

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Exemption Shelter PlanTax Analysis

Husband WifeTentative Taxable Estate $5,000,000 * $4,400,000

Marital Deduction $4,000,000 $ 0

Taxable Estate $1,000,000 $4,400,000

Tentative Estate Tax $ 345,800 $1,932,800

Applicable Credit Amt. $ 345,800 $ 345,800

Estate Tax Due $ 0 $1,587,000

Total Tax Paid: $1,587,000 *Assumes Assets Appreciate 10%

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To Achieve Applicable Exclusion Shelter Plan, Avoid

Common Mistakes

• Leave Everything to Spouse

• Improper Use of Jointly Held Property

• Everything Owned by One Spouse

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Liquidity Needs In Estate Planning

• Administration Expenses 2-5% of

Gross Estate

• State Death Taxes

• Federal Death Taxes (within 9 months)

…often Deferred to Second Death

• Family Income Needs

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Sources of Liquidity

CashLife Insurance

C.D.’s

StocksBonds

Annuities

Business Real Estate Equipment

Liquid

Semi Liquid

Illiquid

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METHOD TO PAYCash

• Reduces Total Bequest to Family

• Reduces Funds Family May Need for Current Expenses

• Future Earnings on Funds Gone Forever

• Capital to run Company is Gone

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METHOD TO PAYSale of Illiquid Assets

• Reduces Total Bequest to Family

• Complete Loss of Future Income

• Unlikely to Receive Fair Value

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METHOD TO PAYLife Insurance

• Pay Estate Taxes with Discounted Dollars

• Death Benefit May Be Estate Tax Free

• Helps Preserve Assets - including the Business

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Possible Solution

Via Gifting, Shift Assets to Create Tax Liquidity

ESTATE

$5 millionTrust

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What Type• Term• Whole Life• Whole Life / Term Blend• Variable• Universal• Variable Universal• No Lapse Universal• Second to Die

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Life Insurance: Powerful or Powerless?

• Assure that you have a Unilateral Contract

• Common Sense: Generally, something is the “cheapest” for a reason

• There are more then 2,000 life insurance companies. There is a wide range in quality –

both company and product.

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“I thought Life Insurance was Tax Free”

• Income and Estate Tax Situations

• Ownership of Policy must be set up correctly

• Three Party Contracts

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METHOD TO PAYInstallments - Section 6166

• Estate Must Qualify – Business Interest must be at least 35% of overall value

• Payments Due Over 14 Years• Interest only first four years• Principal and Interest over Remaining 10

years• This method typically costs two to three

times the original tax due

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Review of Payment Options for $5,000,000 Liability

Option A: $5,000,000 (Cash)

Option B: $5,000,000+ (Sale of Assets)

Option C: Significantly Less (Life Insurance)

Than $5,000,000

Option D: $5,000,000+++ (Section 6166)

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Potential Significant Value “Unneeded” Life Insurance Policies

• Certain policies (depending on age, health, and policy status) are very attractive to outside buyers

• Payout to policy owner substantially more than actual cash value

• Most recent example

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Valuation Important for Lifetime Gifts and Testamentary Transfers

Fair Market Value

What a Willing Buyer Would

Pay a Willing Seller, Neither Being

under a Compulsion to Buy or Sell

and Both Knowing All Relevant Factors

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ValuationIRS Revenue Rulings

Key Ruling - 59-60

EarningsCapacity

Book Value

DividendCapacity

Marketability

Risk CloselyHeld

Market Factor

Publicly Held

Minority Discounts

Control Premium

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Buy-Sell Agreements

• Business Owner’s Agreement

• Sale Triggered by Death, Disability, or Retirement

• Guaranteed Purchase of Appropriate Interest by Business or Remaining Owners

Guaranteed Purchase dependent on buyout method

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Advantages of a Formal Buy-Sell Agreement

• Surviving Owner maintains Continuity of Ownership and Management

• Decedent’s Estate / Family Converts Unmarketable, Non-Liquid Business Interest to Cash

• Provide Fair and Reasonable Price• Possibly Peg the Value for Federal Estate

Tax Purposes

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Business or Surviving Shareholder Required Financial Obligation

$ 2 MILLION BUYOUT AMOUNT

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What are the Choices?

• Sinking Fund

• Borrowing

• Installment Method

• Life Insurance

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What are the Costs for each method?

• SINKING FUND - $2,000,000

• BORROWING - More than $2,000,000

• INSTALLMENTS - More than $2,000,000

• LIFE INSURANCE - Significantly Less Than $2,000,000

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Case StudyF&F, Inc.

• Fred and Freda are equal owners of F&F, Inc. – a profitable S Corporation

• F&F, Inc. valued at $4,000,000• Buy-Sell Agreement requires surviving

owner to purchase deceased owner’s interest for $2,000,000 under an installment contract payable over 10 years PLUS interest

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Installment Method Overview

• Installment payments are NOT deductible by F&F, Inc.

• Fred and Freda both in 40% marginal federal and state tax bracket (no corporate tax)

• F&F, Inc. operates on profit margin of 10% for every dollar of sale

• Annual Payments are $200,000 (not including interest)

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Installment MethodTrue Cost

• Annual Installment Payment is $200,000 (not including interest)

• Surviving Owner has to earn over $330,000 in income to net $200,000 in a 40% marginal federal and state tax bracket

• To earn $330,000, the surviving owner has to generate annual sales of $3,300,000, which is $33,000,000 over the ten year installment period!

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Installment Method Issues

• Could either surviving owner generate enough profit to pay the installment obligation AND still earn a good income for his or her personal needs?

• Will the death of an owner have a negative impact on sales? How is that going to be made up?

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Installment Method IssuesContinued

• Will the survivor have to hire someone to take over the responsibilities of the deceased owner? Where is the cash flow coming for this? How much more is needed?

• Will the installment obligation affect the ability of the Company to pay salaries, borrow money or expand or fulfill other business purposes?

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What Happens…..

• To existing company debt when one owner is deceased or out of the business because of a disability?

• If the company or surviving owner becomes insolvent during the installment period?

• If the surviving owner dies or becomes disabled during the installment period?

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Types of Buy-Sell Plans

• Stock Redemption

• Cross Purchase

• Wait and See

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Key ComponentsBuy-Sell Agreement

• Language that addresses all contingencies

• Valuation

• Funding

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Stock Redemption Plan

• “A” and “B” Form Corporation & Each

Contributes $100,000• 10 Years Later Corporation is Worth $4,000,000• “A” and “B” Enter Into a Stock Redemption

Agreement• Corporation Becomes Owner and Beneficiary of

$2,000,000 Policy on Both “A” and “B”

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Stock Redemption Plan

“A” Dies:

• $2,000,000 Death Benefit is Paid to the Corporation

• Corporation pays $2,000,000 to “A”s Estate• “A”s Estate Redeems Stock Back to Corporation• “B”s Stock is Now Worth $4,000,000 (Same # Shares, Twice the Value)

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Stock Redemption Plan

• “B” Decides to Retire and Sell Corporation for $4,000,000

• “B” Must Pay Capital Gains taxes on $3,900,000 ($4,000,000 Minus Original Cost Basis of $100,000)

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Cross Purchase Plan

• “A” and “B” Form Corporation & Each

Contributes $100,000

• 10 Years Later Corporation is Worth $4,000,000

• “A” and “B” Enter Into Cross Purchase Plan

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Cross Purchase Plan

• “A” is Owner and Beneficiary of $2,000,000 Policy on “B”

• “B” is Owner and Beneficiary of $2,000,000 Policy on “A”

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Cross Purchase Plan

“A” Dies:

• “B” is Paid $2,000,000 from Policy on “A”s Life

• “B” Pays “A”s Estate $2,000,000 for “A”s Stock

• “B” now Owns $4,000,000 of Company Stock

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Cross Purchase Plan

• “B” Decides to Retire and Sell Corporation for $4,000,000

• Since “B” bought “A”s Stock for $2,000,000 and had $100,000 Original Basis…

• …”B” Pays Capital Gains Taxes on $1,900,000

• RESULT…. Tax Savings on $2,000,000

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SPECIAL CASE STUDY

CONCRETE MASONRY, INC.

SUCCESSION PLAN

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Facts• Louie and Louise Young (Husband and Wife)

Ages 63 and 61, Respectively• Three Children:

Joe, Age 31 and Unmarried Moe, Age 28 and Married to Nora Helena, Age 25 and Married to Ken• Louie, Louise, Joe, Moe each own 25%• Fair Market Value of CMI, Inc. is $5,000,000• Louie and Louise Estate Valued at $7,000,000

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Current Plan

• Louie and Louise have I Love You Wills

• At Second Death, Estate is Distributed Equally among the Three Children

• There is no Buy-Sell Agreement

• Moe and Helena have I Love You Wills

• Joe does not have a Will

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Goals

• Distribute the Estate Fairly Upon the Last to Die of Louie and Louise

• Assure that CMI is Run by the Two Sons Who are Active in the Business

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Possible Results of Current Plan after Death

Louise

25 Shares

Louie

25 Shares

Joe

42 Shares

$500,000

Moe

42 Shares

$500,000

Helena

16 Shares

$500,000

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Possible Results of Current Plan

At Moe’s Subsequent Death

Moe

Joe

42 Shares

Helena

16 Shares

Nora

42 Shares

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Possible Results of Current Plan at Moe’s Subsequent

Death

• Nora and Helena May Sell CMI to Strangers/Competitors

• Joe May Lose Control of CMI

• Who is Running CMI?

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Solutions/Step-OneCross Purchase Agreement

I Love You Will/Exemption Shelter

LouiseLouie Brothers Purchase Shares at Second Death

Cross Purchase

Joe Moe

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Solution/Step TwoContingent Beneficiary

• After Sons Buy Shares, Estate Has $5,000,000 in Newly Created Liquid Assets

• Parents now Have the Ability to Increase Cash Distribution to Helena

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Possible Results/New PlanCross Purchase Agreement

LouiseLouiePurchased Shares at Second Death

Cross Purchase

Joe Moe

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Possible Solution Totals

Joe

$1,500,000

50 Shares

Moe

$1,500,000

50 Shares

Helena

$4,000,000

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QUESTIONNAIRE

Questionnaire may be completed and handed in or returned via fax or mail

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CONTACT INFORMATION

Terrance K. Resnick

Resnick Associates

2073 Doral Drive

Harrisburg, PA 17112

(717) 652-2929

(717) 540-5735 fax

[email protected]