The Planning Process: Business Owner Planning

Tell us your situation and we'll help you develop clear and understandable solutions. Feel free to contact us regarding any of your concerns. We can assist with your business, investment and insurance needs, including the following:

Buy-sell agreements
Gifts of corporate stock
Life insurance
Private annuities
Self-canceling installment notes
Family limited partnerships
Management control

A buy-sell agreement is a contract between two or more business owners that outlines the terms of ownership transfer in the event that an owner retires, divorces, becomes disabled or dies. Provisions in any buy-sell agreement also should address the possibility of bankruptcy or loss of a professional license and should be based on a mutually agreed upon market value of the business. Corporate buy-sell agreements are usually structured in one of three ways: stock redemption, cross purchase or a "wait and see" agreement.

• Stock redemption occurs when the corporation buys back stock from the shareholder or a deceased shareholder's estate.
• Cross purchase agreements call for the remaining shareholders to buy the stock of the departing or deceased shareholder.
• "Wait and see" is a hybrid agreement designed to give individuals the flexibility to determine an appropriate buy-sell plan - given tax laws, the market environment, business and family situations - at the exact moment needed.

Making a lifetime gift is often the most effective way to reduce estate taxation. It is common practice for a financial plan to include a model of the asset base and cash flow requirements of the donor before making significant gifts. Gifts can be made outright or in a trust. The basic benefits of gifting include:

• Shifting the income and growth of an asset out of a higher income tax bracket.
• Tax leveraging.
• Allowing a "testing ground" for future management skills.

Life insurance offers a practical and popular planning tool because of its premiums relative to policy proceeds and its estate liquidity. Proceeds can be subject to estate tax, however, so it's a good idea that the life insurance be owned outside of the estate to avoid inclusion of the proceeds for tax purposes. Placing life insurance in an irrevocable trust or ownership by adult children are two solutions to accomplish this.

Private annuities are ideally suited for family situations where a parent wishes to transfer an asset such as a business interest to the next generation free of estate taxes. Typically the parent sells the asset to the child, who in return promises to pay the parent an income for life. This is a legally enforceable contract right, but is not secured.

To be successful, the present value of the annuity payments have to be equal to the fair market value of the asset being sold. The child takes the risk that the parent lives past the life expectancy; the parent takes the risk that the child will not meet the current payment schedule.

A SCIN is an installment debt obligation that by its terms is extinguished at the death of the seller. It is similar to a private annuity in that an asset is sold on an installment basis. However, with a SCIN, the installments are usually shorter than the seller's life expectancy. The buyer (child) usually pays a "risk premium" in the form of an above-market interest rate to the seller (parent) as a consideration for the cancellation provision. Generally, nothing will be included in the seller's gross estate, but any deferred gain on the installment obligation will be reported for income tax purposes.

In addition, management may not be able to react quickly in situations that require shareholder or board approval. Finally, the initial cost of registration and continuing compliance can be high - including reporting requirements, board of director and shareholder meetings, proxy solicitations and investor and financial community relations.

A family partnership may be used to shift both the income tax burden and the appreciation of assets from parents to children or other family members. It is possible to transfer business interests to children and maintain control by retaining the general partnership interest. You can receive a discount, for gift tax valuation purposes, if the partnership interest transferred is a minority interest. Discounts also can apply due to the lack of marketability of partnerships. Any appreciation on transferred interests should not be included in the transferor's estate, assuming a valid partnership has been established.

You may wish to transfer the equity of your company to family members by gift, bequest or sale, yet still be uncomfortable with the new shareholder's business insight. In that case, consider one of the following solutions:

• Voting agreements are one of the easiest and least expensive techniques to retain management control. Business matters are put to a shareholder vote and decisions are based on a pre-determined scope of the voting agreement.
• A proxy is written authority given by a shareholder to another person to vote on shareholder matters. Typically, a proxy statement is for management to vote the shares of shareholders unable to attend a specific meeting, but the scope of proxy authority doesn't have to be limited to that alone.
• Voting trusts are used when voting parties agree to surrender their stock to trustees who represent the parties to vote the stock. Often shareholders receive a trust certificate as evidence of their beneficial ownership of stock held by the trust. The voting trust agreement is usually more difficult to break than a simple voting agreement and can be designed to give trustees full discretion on voting the stock or to be more restrictive.

In addition, management may not be able to react quickly in situations that require shareholder or board approval. Finally, the initial cost of registration and continuing compliance can be high — including reporting requirements, board of director and shareholder meetings, proxy solicitations and investor and financial community relations.