Getting the Business Prepared for Transition: Estate and Tax Considerations
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Transcript of Getting the Business Prepared for Transition: Estate and Tax Considerations
GETTING THE BUSINESS PREPARED FOR TRANSITION:
ESTATE AND TAX CONSIDERATIONS
Anthony J. Madonia, Founder
233 S. Wacker Drive, Suite 6825Chicago, IL 60606-1609
312-578-9300
ANTHONY J. MADONIA Founder and President, Anthony J. Madonia & Associates,
Ltd. Bachelor of Arts in Accounting from University of Illinois Juris Doctorate from John Marshall Law School Certified Public Accountant
Practice focus Estate Planning and Administration Business Planning Corporate Law Taxation
Member American Bar Association American Association of Attorney-CPAs The Justinian Society of Lawyers
Past Chair Asset Protection Committee of the Chicago Bar Association
TAXES GENERALLY DUE UPON SALE
Capital Gains Excess of the amount realized over the adjusted
cost basis
Recapture of Certain Depreciation Taxed as ordinary income
State and Local Taxes May Involve Capital Gains, Sales, Use Taxes May Involve Multiple States
CONSEQUENCES OF TYPICAL BUSINESS SALE
Liquidity
Higher tax bracket
Ability to Directly Manage the Business
Income from After-tax Proceeds May Be Less
ESTATE AND TAX SOLUTIONS
Transfer of business interests to family members
Outright gifts Irrevocable trusts for the benefit of children Family limited partnerships
Irrevocable Life Insurance Trusts
Grantor Retained Annuity Trusts
Charitable Remainder Trusts
Buy-Sell Agreements
Equity Stripping
TRANSFERS OF BUSINESS INTERESTS
TO FAMILY MEMBERS
Move Interests From Selling Entity When Values Are Low
Future Generations Receive Benefits of Sale Proceeds When Sales is Complete
Asset Outside of Taxable Estate
EARLY ESTATE PLANNING REQUIRED
GIFTS TO FAMILY MEMBERS
Lifetime gift tax exclusion $5.34MM – Individual $10.68MM - Married Couple
Annual Cash/Assets Exclusion $14,000 – Individual $28,000 – Married Couple
Annual Gift Tax Free Gifts
GIFTS TO FAMILY MEMBERS
Benefits Removes assets and resulting capital gains from
your estate Allows you to pass shares or business interest to
future generations
Considerations No certainty to future exclusion or tax rate Outright gifts do not come with any asset protection Loss of control over shares or other gifted assets Future generations are responsible for capital gains Cost basis carries over to next generation
LARGER TRANSFERS
Gifting More Than Annual or Lifetime Exclusion
There are methods available to compress the value of shares that are sold or giftedFractionalized ownershipRestrictions on transfer and management
STRUCTURAL CHANGES TO CONSIDER
Large Gifts of Shares May Fit Within Lifetime Gift Exemption
Valuing Closely Held Entities Market method Income method Net asset value method
IRREVOCABLE TRUST
Benefits Your Children/Heirs
Shares are Not Included in Business Owner’s Estate
Children Can Take Advantage of Appreciation of Shares Without Gift or Estate Tax
Option for Tax Flow-Through Grantor Trust Trustmaker either gifts or sells assets to the trustAssets Can Be: C-Corp, S-Corp, Partnership or LLC
IRREVOCABLE TRUST
Benefits Trustmaker’s Estate Reduced for Estate Tax
Purposes Value of Property in Trustmaker’s Estate Frozen All Appreciation Passes to Trust Beneficiaries
Without Gift or Estate Tax Trustmaker Pays Taxes on Trust Income Resulting in
Faster Growth of Beneficiaries’ Share of Trust Assets Transactions Between Trustmaker and Trust Have
No Income Tax Consequences; Thus no gain/loss recognized on sale
Trustmaker Can Retain Management Duties Over Business
FAMILY LIMITED PARTNERSHIP
All or Most of Partners are Family Members
How it works General Partner Contributes Business Interests to the Partnership
in Exchange for Limited Partnership Interests General Partner Gives All or Portion of Interests to Their Children General Partner Retains Management and Control Over Assets
Provides Protection of Family Assets Upon Divorce Interest Likely Characterized As Non-Marital Property, Not Subject
to Equitable Division
Partnership Agreement May Provide Involuntary Transfer (i.e. Divorce Court Award) is Subject to Buy/Sell Agreement Provisions Requiring Purchase by Divorced Partner
FAMILY LIMITED PARTNERSHIP
Overall Benefits Achieves a Variety of Business, Estate, Tax Objectives Provides Centralized Management of Family Assets Avoids Family Disputes Allowing Smooth Transition of
Power Upon Death of Senior Generation Simplifies Gifting Especially Real Estate and Intellectual
Property
Tax Benefits Reduces the Taxable Estate of the General Partner Limited Partners Have No Right To Control Limitations on Transfer Receives Pass-Thru Entity Treatment for Federal Income
Taxes May Be Terminated Without Adverse Income Tax
Consequences
FAMILY LIMITED PARTNERSHIP
Estate Benefits Decedent’s Estate or Trust Will Hold Partnership
Interest vs. Assets, Greater Degree of Confidentiality
Asset Protection Benefits Creditors May Not Force Distributions Creditor Attached to a Partner’s interest, Does Not
Become a Partner, Cannot Vote or Cause Dissolution of the Partnership; They Merely Become an AssigneeAssignee’s only right is to receive distributionsAssignee is taxed on its share of the partnership’s
income, making it pay tax on income it cannot reach.
IRREVOCABLE LIFE INSURANCE TRUST (ILIT)
Option for Business Owners with a High Net Worth Due to Estate Tax Exposure in Buy/Sell Agreements
How It Works ILIT trustee and Other Business Owners Enter Buy-Sell Agreement
Owner’s ILIT Purchases Life Insurance Policies on Other Owners
Owner Provides Funds for the ILIT Trustee to Pay Premiums by Making Gifts/Loans to ILIT
Shareholder Agreement Provides for Buyout by ILIT
Upon Owner’s Death, ILIT Trustee Receives Proceeds; Uses Them to Purchase ILIT’s shares of Deceased Owner’s Interest
IRREVOCABLE LIFE INSURANCE TRUST
Benefits Business Interest Purchased by the ILIT is Not
Included in Owner’s Taxable Estate
Provisions of ILIT Can be Drafted to Accomplish Owner’s Objectives
Upon owner’s death, ILIT Can Become Owner of His Share of Business, Leading to Centralized Management of Business Interest for Beneficiaries
GRANTOR RETAINED ANNUITY TRUST (GRAT)
Irrevocable Trust Where Grantor Retains Right to Receive a Fixed Annual Amount From Trust For Fixed Period After Initial
Contribution
After Fixed Period GRAT Terminates Remaining Assets Are Either Continued in
Further Trust or Distributed Outright to Beneficiaries
Initial Contribution of Property is Subject to Gift Tax
Any Appreciation of the Property is not subject to addt’l gift taxes
GRANTOR RETAINED ANNUITY TRUST (GRAT)
Benefits Owner Keeps All or Most of the Business
Income Owner Retain Management Control Before
Passing It to Beneficiaries Keeps Transfer of Ownership from Becoming
Public Asset Protection for Current and Future
Generations
CHARITABLE REMAINDER TRUST (CRT)
Irrevocable Trust with Income Paid to Trust Beneficiaries for a Term or Life with Remaining
Assets Going to Charity
How It Works Business Owner Contributes Ownership Interests to CRT
CRT Sells Interest to a Third-party Buyer
CRT Does Not Incur Capital Gains Tax on the Sale Transaction
CRT Uses Cash Left to Make Annuity Payments to Owner and Spouse for Life
Upon Death of the Owner and Spouse, CRT Terminates and Remaining Balance is Paid to Designated Charities
CHARITABLE REMAINDER TRUST (CRT)
Benefits Owner Receives Charitable Deduction Upon Transfer of
Assets to CRT When CRT Sells Stock or Other Business Interests, No
Capital Gains Tax is Paid (More Money for Trust Beneficiary Payout)
CRT Itself is a Tax-Exempt Entity; Not subject to tax Beneficiaries Pay Tax on Income Distributions from CRT Interest in CRT is Not Included in Owner’s Estate
Possible Downside Assets are Ultimately Passed to Charity, Not to Future
Generations; However, Tax Savings and Increased Cash Flow Can Be Used to Purchase Insurance for ILIT for heirs
OTHER CHARITABLE GIVING OPTIONS
Charitable Gift Annuities Gift of Cash or Other Assets to Charity in Return for
Amount of Income for Life
Charitable Lead Trusts Provides Income Stream for Charity for Set Period of
Time, Then Transfers Trust Assets to Named Beneficiaries
Donor Advised Funds
Private Charitable Foundations
BUY-SELL AGREEMENTS
Contracts Between Business Owners or Between Business Owners and Their Business
These Contracts Become Part of Corporate Bylaws, Shareholder Agreement, Partnership Agreement or LLC Operating Agreement
Can Be Updated Periodically as Needs and Assets of Business Change
BUY-SELL AGREEMENTS
Why Have a Buy-Sell Agreement?If a Business Owner Dies Without a Buy-Sell
Agreement or Some Other Arrangement for His Shares in a Business, Those Shares Will Pass to
Beneficiaries As Indicated in Will, Trust or State Law
Possible Disputes and Disruptions Heirs May Wish to Sell Their Shares to Company
but Company Does Not Offer a Fair Price Heirs May Wish to Sell Shares to Outsiders, Who
May Not Be Compatible with Other Owners Heirs May Decide to Retain Shares, but Lack
Expertise Needed to be Involved in Business
BUY-SELL AGREEMENTS
Value of Buy-Sell Agreements Prevent Disputes and Disruptions Good Succession-Planning Tools For Share
Valuation Valuable Estate Planning Tools for Shareholders
The Basics Restrictions on Share Transfers Pricing Mechanism Method for Funding the Buyout
ADDITIONAL ASSET PROTECTION CONSIDERATIONS
Equity StrippingConsideration for Valuable Assets (i.e. Inventory,
Equipment, Patents, Trademarks, Accounts Receivable) Protect By Stripping Assets of Their Equity
Borrow Against Asset; Give Another Party a Lien for the Debt
Create LLC to Reduce Chance of All owners Being Debtors of Common Creditor
Lease-back Arrangements
Benefit Control and Enjoyment of Asset; Less Tempting for
Creditors
Caveat Fraudulent Transfers Tax considerations
Questions?
Anthony J. Madonia, FounderAnthony J. Madonia & Associates, Ltd.
233 S. Wacker Drive, Suite 6825Chicago, IL 60606-1609
312-578-9300