Integrated Risk Planning

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This presentation was for financial planners and insurance professions on risk planning concepts including trusts, business entities and estate planning strategies.

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  • Effective planning addresses the business owner’s needs during life and the needs of the owner’s family after death. Estate planning is difficult to implement when the majority of the owner’s assets consist of her interest in a closely held business.
  • All qualified retirement plans are fully exempt in bankruptcy. IRAs are now also shielded, up to a maximum of $1 million plus any amounts rolled over from a qualified plan. With this new level of protection, designing an appropriate retirement plan may be an important part of an asset protection strategy. CLAWBACK - 2005 law 10 year clawback for self-settled trusts transfers to “hinder, delay or defraud creditors.” All transfers to asset protection trusts subject to being set aside for 10 prior to filing of bankruptcy petition. Ordinary preferential transfer period is two years in bankruptcy. (2005 Act). Includes “similar devices” –could be applied to trusts settlor has limited interest. Also, what a “Swiss Annuity” type products and variable universal life products that give their purchasers some investment control, access to cash value, and have only a minimum amount of pure life insurance ? Creditor could argue they are in nature of self-settled trusts and include only enough insurance for tax purposes. Under FCS and Bankruptcy code “actual intent” does not require confession by debtor, but can be proven by circumstantial evidence. Use of “Badges of Fraud”. Under Bankruptcy code also applies to transfers in anticipation of judgment or fine from violation of securities laws. Self settled trusts included in bankruptcy estate if trustor has direct or indirect control over distribution of assets. Bankruptcy judges often treat trusts as agency relationship. A popular asset protection technique, known as a self-settled asset protection trust, can be set aside in bankruptcy if it was established within ten years and intended to hinder, delay, or defraud a creditor. These types of trusts are typically Delaware or Alaska trusts or some- times created as Offshore Trusts. The planning may be very sound when established early and with the proper motivation but existing self-settled trusts should be reconsidered with proper regard for the new law. The new law, which applies to bankruptcy filings, curbs this per- ceived abuse by limiting the exemption to $125,000 for amounts invested in a home within the prior forty months.
  • NON DISCHARGEABLE DEBTS Criminal Fines and debts-Criminal judgments; debts or judgments result of personal injury or death to others Student Loans Taxes due within the last three years Fraudulent debts eg. Credit card debt within 90 days of filing Dischargeable debt to pay off non-dischargeable debt- credit card advance to pay off taxes Alimony and child support PREFERENCES 1. To a creditor as payment on a debt you owed 2. While you were insolvent 3. Within 90 days before you filed for bankruptcy, or within one year if the payment or transfer was to an insider creditor, such as a family member That enables the creditor to receive more than it would have received if your property and assets were distributed to all creditors in a Chapter 7 bankruptcy LIEN STRIPPING Lien stripping is an example of debt avoidance , a legal term that basically means having a debt legally cancelled or reduced. A lien can also be stripped if it is a judgment lien that is undersecured and impeding a debtor’s homestead. Other common examles of avoidance on other property and houses other than the debtor’s primary residence include the ability to cram down the lien or mortgage to the value of the property, bifurcating the lien obligation into secured and unsecured elements.
  • SELF SETTLED TRUST ==Create a trust for your own benefit is “self settled trust”. If it contains a provision that prevents your creditors from reaching your interest in the assets, the trust is known as a “self-settled spendthrift trust” or “asset protection trusts. ILIT= One method of reducing the impact of estate taxes on the value of your estate is by purchasing a life insurance policy with a death benefit equal to the amount of taxes your estate will owe at your death.  The policy is then placed into an irrevocable life insurance trust (ILIT). 1. do not own the policy on your own life or the value of the policy will be included in your estate, increasing the amount of taxes you are trying to avoid. 2. If you already have an insurance policy, you can gift the policy to the trust, making the trust the new owner of the policy. However, if you die within three years of transferring an existing insurance policy into the trust, the IRS will include the death benefit in your estate. 3. The ILIT is irrevocable and contributions to the trust cannot be undone. In addition, you cannot be the trustee of the trust. 4. If you transfer an existing policy to the trust that has any cash value, it is considered a gift. If the policy has a high cash value (over $13,000), gifting the policy to the trust could result in a gift tax. DOMESTICT ASSET PROTECTION TRUSTS== Self settled spendthrift trust in one of the states that has passed favorable debtor legislations regarding these trusts. Domestic asset protection trusts are basically self-settled trusts enacted in domestic jurisdictions which have en- acted the requisite legislation. Furthermore, due to the fact that domestic asset protection trusts are relatively new, there has been no litigation either upholding or defeating their validity or effectiveness. Therefore, it is generally believed that these types of trusts will currently be most effective for individuals residing in jurisdictions which have enacted domestic asset protection legisla- tion. FOREIGN ASSET PROTECTION TRUSTS = Self settled spendthrift trusts set up in foreign jurisdictions with laws favorable to protection of assets such as shorter statute of limitations, ability for trustees to move jurisdictions, and arguably control litigation over the trust operation.
  • An irrevocable life insurance trust (an "ILIT") is an irrevocable trust created for the principal purpose of owning a life insurance policy. As with any other trust, the insurance trust is a contract between a grantor and a trustee to administer certain property, in this case an insurance contract, for the benefit of named beneficiaries. The insurance trust, like other irrevocable trusts, cannot be rescinded, amended, or modified in any way after it is created. Once the grantor contributes property to the trust, he cannot later reclaim ownership of the property or change the terms of the trust. One of the primary reason executing a life insurance trust is estate tax considerations. If an ILIT is properly structured, the death benefits paid to the trust will be free from inclusion in the gross estate of the insured. In addition, the ILIT can also be structured so that the trust will provide benefits to the insured's surviving spouse without inclusion in the surviving spouse's gross estate either. Money used to pay the life insurance premiums is generally transferred out the grantors estate gift tax free, thereby saving the estate tax on every dollar transferred in to the ILIT. The “leveraged” return from life insurance can be tremendous. Your life insurance agent can explain the potential value of this aspect of life insurance. Remember the death benefit of the life insurance policy is completely exempt from income and estate tax in a properly drafted trust. The proceeds from the life insurance would be available to the estate to provide for the payment of estate and other taxes and to provide support, maintenance, education, health and other important needs of family members. The money provided by the insurance in the trust could be very usefully if the estate has a large retirement account because it could be used to pay taxes in the value of the retirement account and the money in the account could remain in the retirement longer and continue the grow tax free or tax deferred. The trust can provide leverage with the Generation Skipping Tax exemption for the benefit of grandchildren. Your tax professional, attorney of insurance agent can explain this more thoroughly.
  • WHEN WILL THEY WORK ? Establish a presence or residence in the other state. Have assets in the other state. Fund the trust well in advance. Keep property in that state, including banks that have no branches in non-trust states. If you live in Delaware, form a foreign asset protection trust, keep all assets abroad, and move to foreign jurisdiction if problems are on the horizon in the future.
  • DEFECTS IN USE Trustee Subject to US Jurisdicition—US court can compel trustee to take certain action or be thrown in jail. Trustee also vulnerable to a civil lawsuit and is also available to law enforcement and potential money laundering charges. Full Faith and Credit- State must recognize judgment from another state. Creditor registers judgment in other jurisdiction without having to retry the case. Choice of Law- Unclear if choice of law provision in favor of Delaware law may not be enforced. Would Oregon judge enfoce choice of law in this case? Federal Courts— Due to supremacy clause they will ignore state law. Some contempt cases on foreign asset protection trusts could be applied to domestic trusts.
  • SPECIFIC BENEFITS Carry Out Wishes of Trustor ( Maker) Freedom of Disposition Prudent Investor Rule-intentions of trustor Protect Trustees From Liability Traditional Fiduciary Liabilities Use of Advisors Employment of Agents Adherence to the terms of the Trust Agreement Delaware Income Tax Benefit No income tax on trust income-non resident beneficiary Effective Enforcement of Trust Agreement Trust matters adjudicated in Delaware Confidentiality of trust respected by Court No Change in Current Trust Current Advisors Transfer to Delaware- same advisors, trust protectors and delagees of trustor’s duties Procedure to Change Situs of Irrevocable Trust File an action in Delaware Chancery Court to reform trust Distribute assets to a new Delaware Trust Invade Principal to make distributions for benefit of beneficiaries Exercise authority in favor of second trust Does not reduce any income interest of any income beneficiary Does not apply to property subject to presently exercisable power of withdrawal
  • In order to mitigate these risks, it may be beneficial to maintain more control over the trust assets placed in a foreign asset protection trust. To accomplish this goal, family limited partnerships (FLPs) or limited liability companies (LLCs) may be used in tandem with foreign asset protection trusts. In order for the settlor to retain control over the transferred assets while relinquishing ownership of the assets, generally the settlor either owns a minimal general partnership interest in the FLP, with the trust owning the limited partnership interests; or the settlor is named as the manager of the LLC with the trust owning the LLC interests. While the utilization of FLPs and LLC in tan- dem with offshore trusts is a complex asset protection strategy, it can also produce beneficial results. However, as with domestic asset protection trusts
  • ANDERSON Federal Trad Commission v. Affordable Media, LLC, 179 F2d 1288 (9th Cir. 1999)/ IRREVOCABLE COOK ISLAND TRUST 1995 CHILDREN BENEFICIARIES 6 MONTHS LATER ANDERSONS ADDED AS BENEFICIARIES-MISTAKTE 1 ANDERSONS SERVED AS CO-TRUSTEES AND TRUST PROTECTOR-SECOND MISTAKE EVENT OF DURESS PROVISIONS ASSETS: CASH AND 98% INTEREST IN US CORP. ANDERSONS CARRIED ON BUSINESS IN US AS TELEMARKERS 1995-1997 REGULAR DISTRIBUTIONS TO TRUST 1997- MEDIA INVESTMENT-PONZI SCHEME INVESTORS LOST $13 MILLION AND ANDERSONS $6.3 COMMISSIONS ANDERSONS MADE DISTRIBUTIONS IN 1997-1998 THAT WERE CHALLENGED BY FTC WHO GOT A TRO THEN PREMILINARY INJUNCTION FOREIGN TRUSTEE , ON ADVICE OF COUNSEL, REFUSED TO REPATRIATE FUNDS TO US THE COURT HELD THE ANDERSONS IN CONTEMPT ANDERSONS ASSERTED IMPOSSIBLITY DEFENSE NO FRAUDLENT CONVEYANCE- TRUST ESTABLISHED TWO YEARS EARLIER AND NO EVIDENCE OF INVOLVENCY PAYMENT OF TAXES BY TRUST REFUTED IMPOSSIBILITY MISTAKE TO SERVE AS TRUSTEE, TRUST PROTECTOR AND ANDERSONS ADDED AS BENEFICIARIES RELEASED FROM JAIL, BUT COOK ISLAND COURT REFUSED TO APPOINT NEW TRUSTEE AND PROTECTOR FTC SUED IN COOK ISLAND, COURT RULED STATUTE OF LIMITATIONS EXPIRED SUMMARY BURDEN OF PROOF ON IMPOSSIBLITY “ PARTICULARLY HIGH ” IMPOSSIBILITY MAY BE UNAVAILABE WHEN SELF INDUCED LAWRENCE 238 BR 498 (S.D. FLA 1999) FAILED TO COMPLY WITH TURNOVER ORDER DEBTOR BAD WITNESS LIED IN BANKRUPTCY COURT COURT DID NOT BELIEVE WOULD GIVE UP CONTROL OF 90% OF ASSETS IMPOSSIBILITY NOT AVAILABLE BECAUSE TRUST WAS DEBTORS OWN CREATION SPENT 27 MONTHS IN JAIL/ BUT NO RECOVERY FROM TRUST BRENNAN LEGAL BATTLE WITH SEC BY OWNER OF SECURITIES BROKERAGE FIRM. SEC CHARGED CIVIL AND CRIMINAL FRAUD. GOVERNMENT SPENT $ OVER $1.0 MILLION IN EFFORT TO RECOVER $45.O MILL FROM OFFSHORE TRUSTS SEC OBTAINED JUDGMENT FOR $75 MILLIONIN 1994 BRENNAN ESTABLISHED 3 TRUSTS IN 1993-1995 FOR $25 MILLION—SONS AND CHARITABLE FOUNDATION BENEFICIRIES BANKRUPTCY TRUSTEE FILED SUIT IN NEVIS SO FAR WITHOUT SUCCESS 2000- SEC CHARGE WITH CRIMINAL FRAUD- CONVICTED 5 YEARS AND $4.6 MILLION RESTITUTION. CASE RECENTLY SETTLED UNDER CONFIDENTIAL TERMS. LESSONS TO BE LEARNED ALL BETS OFF IF CREDITOR IS GOVERNMENT MOST BETS ARE OFF IF CREDITOR IS LARGE CORPORATION OR BANK GOVERMENTS VAST EFFORTS DID NOT RESULT IN COMPLETE RECOVERY BAD FACTS MAKE BAD LAW MOVE ONLY LIQUID ASSETS LESS THAN 50% NET WORTH WISE CHOICES IN TRUST DOMICILE TIMING OF TRANSFERS THIRD COUNTRY TRUSTEES TRUST PROTECTORS INVESTMENTS DEPOSITIORY INSTITUTIONS ADEQUATE PROVISIONS FROM US ASSETS TO PAY SUCCESSFUL CLAIMS BY THE GOVERNMENT AND LARGE CORPORTATIONS
  • Take Notes on these three cases
  • An entity’s form of organization generally will have a considerable impact on the personal asset protection risks faced by each of the partners/members of the organization. Generally speaking, the corporate form of organization will provide the most asset protection for the owner’s personal assets because one of the characteristics of the corporate form of organization is limited liability. Additionally, the limited liability company (LLC) or limited liability partnership (LLP) form of organization will also provide substantial personal asset protection for a partner’s personal assets. This occurs because the partners of LLCs or LLPs are generally not held liable for the professional malpractice or tortuous conduct of the fi rm or the other partners and employees of the fi rm. the general partnership form of organization will generally provide the least asset protection for general partners because they will have unlimited personal liability for the professional mal- practice or tortuous conduct committed by the firm and other partners and employees of the firm.
  • The primary distinguishing feature of a corporation is the so-called limited liability of the officers, directors, and shareholders (the “princi- pals”) of the company. In a properly organized, maintained, and capi- talized corporation, the principals have no personal liability for debts of the corporation. vendors sometimes will not sell, and banks and other Lenders often will not lend to a family corporation without a personal guarantee. To the extent that guarantees are provided, an individual owner will have personal liability for these contracts, and the corpora- tion will not provide protection from these obligations. When the source of the lawsuit is a negligence claim or a claim arising out of the employer-employee, relationship, the corporation can be an effective device. We have previ- an employee’s negligence may be imputed to his employer. If the product is faulty or someone is injured by the product, the corporation will be liable but not the principals. If a corporation supplies services, such as contracting or repair work on a house, only the corporation would be liable for faulty services. C corporation disfavored because of double taxation at corporate level and on distributions. The problem of double taxation may be eliminated in one of two ways. First, the corporation can pay out as salary an amount equal to its net earnings. This is called zeroing out the corporation. Internal Revenue Code imposes certain limitations on this technique by allowing a deduction to the corporation, only if the amount of compensation paid to a particular individual is “reason- able.” The salary cannot be excessive based upon the actual services provided by the individual. The second method for eliminating double taxation is the use of a device called an S Corporation. all corporate income is included directly in the income of the shareholders. There is no need to zero out the corporation with salaries since corporate income is now subject to tax only once, at the shareholder level. Additionally, if the corporation has a net loss, that loss can be used by the shareholders to offset other business income. PEIRCING THE CORPORATE VEIL- There are two solutions to this problem. If you are a principal shareholder or officer/director of a corporation, use a proper asset pro- tection plan to shield your personal assets from the potential liability associated with the corporation. Alternatively, use a Limited Liability Company (LLC)—instead of a corporation to conduct business.
  • Absent written partnership agreement treated as general partnership. Jointly and severally liable. The distinguishing feature of a partnership is the unlimited liability of the partners. Each partner is personally liable for all of the debts of the partnership. That includes any debts incurred by any of the other partners on behalf of the partnership. Any one partner is able to bind the partnership by entering into a contract on behalf of the partner- ship.
  • The proper role of the FLP is often to act as a holding company, owning certain assets and interests in other entities. Use a corporation or LLC as the general partner. Limited partner may not participate in management without risk of liability. Liability insulation for partners. No liability insulation for partner’s individual negligence or tortious act regardless of form of entity. Limited partners have no personal liability. The limited partner stands to lose only the amount which he has contributed and any amounts which he has obligated himself to contribute under the terms of the partnership agreement. Limited partnerships are often used as investment vehicles for large projects requiring a considerable amount of cash. Individual limited partners contributing money to a venture, but not having management powers, will not have any personal liability for the debts of the business. In exchange for this protection against personal liability, a limited partner may not actively participate in management. However, it is permissible for a limited partner to have a vote on certain matters, just as a shareholder has a right to vote on some corporate matters. A typical limited partnership agreement may provide that a majority vote of the limited partners is necessary for the sale of assets or to remove a general partner. The partnership agreement determines whether the limited partners can vote on these matters. Since GPs only asset is an interest in the FLP, the creditor would apply to the court for a charging order against Husband’s part- nership interest. A charging order means that the general partner is directed to pay over to the judgment creditor any distributions from the partnership, which would otherwise go the debtor partner, until the judgment is paid in full. In other words, money which comes out of the partnership to the debtor partner can be seized by the creditor until the amount of the judgment is satisfied. Cash distributions paid to GP could, therefore, be taken by the creditor. Foreclosure--A charging order constitutes a lien on the judgment debtor’s transferable interest. The court may order a foreclosure upon the interest subject to the charging order at any time. The purchaser at the foreclosure sale has the rights of a transferee. ESTATE PLANNING BENEFITS-- First, tax savings can be realized by spreading income from high tax bracket parents to lower tax bracket children. Second, estate tax reduction can be accomplished because of certain unique attributes of the FLP. Of primary importance is the ability to shift the value of assets out of your estate through a program of gifting limited partnership interests to your children or other family members. estate tax reduction can be accomplished because of certain unique attributes of the FLP. Of primary importance is the ability to shift the value of assets out of your estate through a program of gifting limited partnership interests to your children or other family members. would have management over the property in the FLP. Initially, they could make a gift of the limited partnership interests to your children (directly or indirectly through a Trust) in an amount equal in value to the combined maximum gift tax credit. Or your could use a portion of your credit now and take advantage of the annual exclusion amount, which is currently $13,000 per person per donee. That would be $26,000 that a married couple can gift to each child without using any portion of their lifetime gift tax exemption. According to IRS rulings and a sig- nificant line of court cases, the value of each gift of a limited partner- ship interest should be discounted in order to account for the lack of marketability and the lack of control associated with those interests. this approach will also remove future appreciation from the estate .
  • Income tax treated as a partnership. Pass through tax treatment. No consequences to transfer to or from LLC. Avoids double taxation.
  • Pass through tax treatment and limited liability, but more complicated to maintain. Limited number of stockholders and single class of stock. In order to qualify, the stock of an S Corporation must be held by one hundred or fewer individuals and all shareholders must consent to the election. One major drawback is that an S corporation is only permitted to have one class of stock, which may limit the use of so- phisticated asset protection strategies which vary the rights of different shareholders. Further, shares of S Corporation stock can only be held by individuals and certain types of trusts.
  • ESTATE PLANNING BENEFITS-- Tax savings can be realized by spreading income from high tax bracket parents to lower tax bracket children and grandchildren or other family members. Any business venture is a Dangerous Asset . There are leases to sign, bank loans, customers, employees, competitors, and government agen- cies—all with the potential to blow you sky high. The Series LLC is a relatively new variation of the LLC, now adopted by legislation in eight states (Delaware, Illinois, Iowa, Nevada, Oklahoma, Tennessee, Texas, and Utah) with more sure to follow as the legal and tax issues are clarified by the states and the IRS. Each unit has its own owners (members) and may be man- aged separately from the master LLC and other units. n Each unit must maintain separate books and records. n As with a regularly formed LLC, the owners (members) of each unit are not financially responsible for the debts and obligations of the other units. n A unit may conduct part of the business of the master LLC, or may conduct a wholly different business. n Each unit has its own assets and liabilities. The members of each unit are treated under the laws of the state where the master LLC is formed as owning an interest in only that unit, and have no rights as members of one unit in the assets or income of any other unit. and grandchildren or other family members. Any business venture is a Dangerous Asset . There are leases to sign, bank loans, customers, employees, competitors, and government agen- cies—all with the potential to blow you sky high.
  • Organizational structure can serve as a means to limit liability and afford asset protection. When risk and problems are “compartmentalized” into differ- ent businesses or business units, a creditor’s claim, although problematic for one business unit, will not destroy the entire entity. This type of asset protection is best illustrated through the example of a large corporation which in structured to have a parent holding company with a number of corporate or LLC subsidiaries. A problem which arises in any one of the subsidiaries would be isolated to that particular subsidiary, and would not destroy the entire company. Thus, the risk is “compartmentalized” and asset protection. Whenever feasible, assets, such as real estate and equipment, surplus cash, inventory, accounts receivable, and intellectual property should not be held by the operating corporation. If the business of the corporation can be divided into separate busi- nesses, both assets and liabilities can be protected or managed through the use of multiple entities, (which may be corporations, LLCs, limited partnerships, or trusts—all of which together are referred to as Special Purpose Vehicles or SPVs). The simplest example of the usefulness of SPVs is a corporation with more than one retail outlet within a single corporation. If business at one of the locations slows down substantially, that outlet may became a financial drain on the others, absorbing all of the available cash in the company. At a minimum, our approach in these situations is to have each store location be separately incorporated. Then, if one were to falter, the liabilities would not drag down the other, still valuable, stores. A judgment creditor of one corporation would not be able to reach the assets of the other companies. Trademarks, patents, and copyrights are valuable assets which should not be owned directly by the operating entity. A separate company can own these assets and make them available through a form of a licens- ing agreement. The objective is to protect these assets in the event of a judgment against the corporation.
  • Within a closely held corporation, shareholders are often concerned about what might occur if one of the owners dies. Will the deceased shareholder’s family retain the economic value of the corporate interest? Can the surviving owners avoid interference from the deceased shareholder’s family? Will the survivors have the economic resources to redeem the deceased owner’s interest? Given these concerns, corporate owners are best served by entering into a buy-sell agreement while they are all alive.
  • Funding without life insurance policies. Although risk-averse shareholders generally prefer to fund buy-sell agreements through the purchase of life insurance, not all shareholders are risk averse. Risk-seeking shareholders have two alternatives: to invest capital in life insurance to fund the buy-sell agreement, or to invest to grow (or perhaps to sustain) the corporate business operations. If capital funds are limited, shareholders may not have the luxury of funding both alternatives. Actuaries typically base premiums on a relatively low rate of return to the insured. If it were not for the favorable tax treatment provided by life insurance proceeds, few would use life insurance as an investment. In contrast, the return on corporate business operations, especially in the early years, may yield substantially greater returns than those offered through life insurance. Thus, risk-seeking shareholders may reason that if they live at least as long as their actuarially determined life expectancy, the return on capital invested should be greater for funds invested in the corporation. Another reason not to fund the buy-sell agreement is that buy-sell settlements often occur at the date of retirement—not at death—leaving no need for life insurance to fund the settlement. Shareholders that decide not to fund settlements with life insurance typically expect that corporate earnings and profits will increase as the corporation matures. In such situations, C corporations often must pay dividends to avoid the corporate accumulated earnings tax. Alternatively, corporations may elect S status, whereby earnings flow through to shareholders and are taxed then at the individual shareholder level. Either way, shareholders will likely incur increased taxes. Regardless of the corporate form, earnings may be strategically accumulated so they can fund needed buy-sell settlements. When the corporation executes the buy-sell agreements, the estate of a deceased shareholder will receive the proceeds for selling the stock without incurring income taxes (the share basis will be the fair market value at the date of death). If the buy-sell agreements are executed at the date of retirement, not at the date of death, retired shareholders will benefit from capital gains treatment. Buy-sell agreements should specify an installment purchase option (rather than the immediate purchase of shares) where time might be needed to accumulate funds for the redemption of the stock (e.g., upon the sudden death of a shareholder).
  • FUNDED WITH LIFE INSURANCE ON WITHDRAWING OWNERS LIFE. ENTITY PURCHASES CORPORATION OWNS POLICY ON EACH OWNERS’ LIFE . Stock redemption agreement , in which the corporation owns policies on the lives of the shareholders. When a shareholder dies, the corporation buys the deceased shareholder’s interest in the company with the insurance proceeds. A prime advantage of the stock redemption agreement is that it is easier to administer for multiple shareholders. An additional advantage to the stock redemption structuring of the buy-sell agreement is that the corporation will bear the premium differences associated with age disparities among shareholders. DISADVANTAGES The earnings and profits will increase with the life insurance proceeds received and decrease as a result of the stock redemption, so the corporation must attend to the overall net effect on earnings and profits and consider how that might affect the dividend policy to shareholders. A significant disadvantage of the stock redemption form of the buy-sell agreement is that the remaining shareholders do not get the benefit of a step-up in basis when the corporation purchases the deceased shareholder’s interest. The continuing shareholders retain their original bases in the company. LOSS OF STEP UP BASIS Compared to the cross-purchase agreement, the stock redemption structuring will create greater capital gains upon the ultimate disposition of shares if made before death. ESTATE TAX Under a redemption approach, however, the estate tax consequences can become more pronounced when the deceased shareholder has a controlling interest. A shareholder who owns more than a 50% interest either directly or indirectly is deemed to control a corporation, under IRC section 267. In this situation, the shareholder is deemed to have an ownership interest in the life insurance policy due to the shareholder’s ability to designate a beneficiary, as well as other ownership interests. The fact that control exists over the policy in majority ownership instances would result in the proceeds being includable in the deceased’s estate. Thus, the after-tax returns on life insurance policies can be substantially reduced if estate taxes are incurred as a result of the life insurance proceeds being included in the estate. ff the family members own the insurance policy on the decedent, they will receive the life insurance proceeds without including them in the taxable estate. Thus, the cross-purchase option may be preferable to the redemption option.
  • OWNERS TAKE OUT LIFE INSURANCE ON EACH OTHER . With a cross-purchase agreement, each owner of the corporation purchases an insurance policy on the other shareholders. The purchaser is both owner and beneficiary of the policies. Upon the death of a shareholder, the other shareholders are then able to use the life insurance proceeds to purchase the deceased owner’s shares. The family of the deceased owner will have a tax basis equal to the fair market value of the decedent’s stock at the date of death, thus avoiding any income tax consequences as a result of the sale. The fair market value of the shares should be defined by the buy-sell agreement The life insurance proceeds received by the surviving owners are not subject to income taxation. For newly purchased shares, the corporate shareholders will be entitled to a tax basis equal to the purchase price. The stepped-up basis should reduce future income taxes if the surviving shareholders later sell their interests. The insurance proceeds are not subject to the corporate alternative minimum tax (AMT) and are also not subject to the claims of corporate creditors. The AMT avoidance and creditor protection exist because the proceeds are paid directly to the individual shareholders.
  • The cross-purchase form of the buy-sell agreement carries several disadvantages. The plan is difficult to administer if there are numerous shareholders that must buy a plan for each other. For example, for seven owners to cross-purchase life insurance would require 42 (7 ¥ 6) policies. The number of policies can multiply even further if disability coverage is also part of the buy-sell agreement. Another disadvantage of the cross-purchase agreement is that age or insurability can create a disparity in premiums. Younger or healthier owners may incur higher premiums to cover older and less healthy owners. A possible solution to this drawback is to have the corporation raise salaries to cover the premiums incurred by the owners. Inequities may persist, however, if owners’ marginal tax rates applied to the salary reimbursements are different. Additionally, cross-purchase agreement adopters should recognize that the cost of funding the buy-sell agreement will be greater if the shareholders have a higher tax rate than the corporation. ESTATE TAX The proceeds from the life insurance are not included in the deceased shareholder’s estate. The deceased is not the owner of the policy and, therefore, the insurance proceeds payable at death are not included in the estate.
  • There is a distinct difference between the values that should be established for the two alternative approaches to a buy-sell agreement. This difference is due to the ownership of the life insurance policy. In a cross-purchase agreement, the deceased shareholder has no economic interest in the life insurance policy on his life. Accordingly, the surviving shareholders should expect to pay the fair market value of the underlying net assets, which represents the value of the business operations. Under the stock redemption approach, the corporation owns the policies, and therefore the value of the corporation includes both the business operations and the insurance policies. The redemption price of a buy-sell agreement should typically include a portion of the life insurance proceeds. If the stock redemption agreement is so structured, the tax implications may be negative, because the life insurance proceeds may be subject to both estate tax and income tax if the decedent is deemed to possess an ownership interest in the policy. Given these tax implications, including the value of life insurance proceeds in the buy-sell valuation price may result in an unsatisfactory after-tax return. Another valuation issue is that the premiums on older shareholders can be considerably higher than the premiums on younger shareholders. As each unit of stock incurs the same cost, older shareholders will incur higher premiums than they would under a cross-purchase plan. Accordingly, younger shareholders expect to reap a greater benefit from the insurance policies than their older counterparts. Thus, younger shareholders would be entitled to a greater benefit at a lower cost under a stock redemption approach than for a cross-purchase approach. This scenario suggests that the redemption price should include a portion of the life insurance payments, unless older shareholders are compensated for the disparity in the premiums. This would convert potentially nontaxable deferred income into accelerated taxable income. It would also precipitate similar adjustments for the purchase price for younger shareholders. The proper pricing for a buy-sell agreement becomes much more complex in the case under the redemption alternative.
  • Structure-PLR200747002 Shareholders execute a cross purchase agreement Shareholders form an LLC The cross purchase and the LLC operating agreement have provisions that reference each other. Special Provisions of LLC Manager of LLC is a corporate trustee Members cannot vote on life insurance policy matters Manager must use life insurance proceeds as required in the buy-sell agreement A capital accont is maintained for each member, with special allocations of premiums and proceeds. Death benefits not in members estate because no incidents of owenrship Benefits are provide to LLC Premiums paid by business entity Payments treated as bonuses if C Corp Business taxed as S Corp, payments treated as shareholder distributions
  • Questions for the business owner : What happens when the current owner dies? How and when should ownership pass? How will owner retire? Willing to part with control before death ? What are the liquidity needs of the estate and the business? How coan transfer taxes be minimized? How do you structure estate plan when only some of the kids want to be involved with the business? GIFTING PROGRAMS : Annual exclusion: $13,000; Lifetime exclusion: $ 5,000,000( in addition to annual)(35%); goal remove assets that are likely to appreciate from estate; transfer assets to next generation that generate income; ;and maximize use of annual gift exclusion. Transferee takes the property with the donor’s basis. Gifting of business interest INTRA FAMILY SALES 1) FREEZE THE ESTATE; 20 INSTALLMENT NOTE OR CASH; 30 PRIVATE ANNUITY; OR 4) SELF-CANCELLING NOTE— BUYERS ADJUSTED BASIS IS AMOUNT PAID FOR INTEREST WHICH CAN BE LESS THAN FAIR MARKET VALUE. ALSO, TAXABLE EVENT FOR INCOME AND CAPITAL GAINS TO OWNER. MUST HAVE AN APPRAISAL OF THE BUSINESS OR ELSE COULD BE CONSIDERED A GIFT. DO NOT STRUCTURE TO LIMIT PAYMENTS TO INCOME OF PROPERTY, RETAINED INCOME INTEREST COULD BECOME PART OF THE ESTATE.
  • Personal Residence Trust (PRT). This is a grantor-type trust, specifically permitted under the Internal Revenue Code. Protection against claims is afforded while the tax benefits of ownership are preserved. A strong degree of control and enjoyment over your home can be maintained, depending upon the terms of the PRT which you establish. Spendthrift Trust This trust is designed to hold assets, including ownership of FLP or LLC interests. It can be flexible in form and should be crafted to based on control and needed access to the assets. Offshore Trusts and Offshore LLCs Those in the high-risk professions and those for whom insur- ance coverage is unavailable. The goal is set up barriers and increase litigation and collection costs to discourage collection and encourage settlement. There are certainly risks and security issues, and the potential for contempt if assets are not returned. You may have to move to the jurisdiction. Limitations on Asset Protection Planning There are important limitations on the value and effectiveness of asset protection plans which should be considered. Costs Risk reduction can be complex and sophisticated leading to high initial expense, high maintenance costs and additional adminstrative work. No Clalm Pending An risk reduction protection plan must be created in advance of any claim or threatened litigation. If you have reason to believe there may be a case against you, the other party has the right to set aside any transfers which you attempt. Offshore Tax and Security Issues How will the plan be treated by a U.S. court? How can you protect the security of the funds in an overseas bank? What is the tax treatment of the structure?
  • Integrated Risk Planning

    1. 1. Preventing Disaster: Planning Across Lines of Business, Personal and Estates Russ Pike Sherman, Sherman, Johnnie & Hoyt, LLP russ@shermlaw.com or 503-364-2281
    2. 2. Overview <ul><li>Risk Planning Concepts </li></ul><ul><li>Different Types of Trusts and Their Uses </li></ul><ul><li>Different Types of Entities and Their Uses </li></ul><ul><li>Integrating Trusts, Entities, and Insurance </li></ul><ul><li>Achieving Risk Reduction – Putting it All Together </li></ul>
    3. 3. Why Risk Planning? <ul><li>Victim oriented society </li></ul><ul><li>Deep pockets </li></ul><ul><ul><li>Substantial insurance </li></ul></ul><ul><ul><li>Significant personal assets </li></ul></ul><ul><li>Increased social media and awareness- nothing is private </li></ul><ul><li>Publicity of judgments against high net worth individuals </li></ul>
    4. 4. Risk Planning Basics <ul><li>Risk Planning is: </li></ul><ul><li>A structure that makes assets difficult or impossible to reach </li></ul><ul><li>Places a portion of your net worth behind some obstacles </li></ul><ul><li>Planning for future liabilities </li></ul><ul><li>Risk Planning is Not: </li></ul><ul><li>Fraud </li></ul><ul><li>Tax Avoidance </li></ul><ul><li>Transferring control of all your assets </li></ul><ul><li>Reliance on Stealth Alone </li></ul>
    5. 5. Risk Planning Concepts <ul><li>Judgment creditors can only take what you own. </li></ul><ul><li>Without your permission, no one can take what you own without winning a lawsuit. </li></ul><ul><li>Timing is of the essence. Risk Planning must be done while the seas are calm. </li></ul><ul><li>Risk protection is a cost-benefit analysis from your standpoint and the predators. </li></ul><ul><li>Never mix liability generating assets (Dangerous Assets) in the same entity with other Dangerous Assets or Safe Assets. </li></ul><ul><li>Insurance is the first line of defense for business and personal protection. </li></ul><ul><li>Every asset you value must be protected and titled properly. </li></ul>
    6. 6. Planning Limitations <ul><li>Fraudulent Conveyance Statute </li></ul><ul><li>Timing the transfer- 4 years look back; one year of discovery </li></ul><ul><li>Not receive “reasonably equivalent value” </li></ul><ul><li>Insolvency test for Oregon </li></ul><ul><ul><li>Debts greater than assets </li></ul></ul><ul><ul><li>Not paying debts when due </li></ul></ul><ul><li>Cannot protect against already incurred debt </li></ul><ul><li>Timing before Bankruptcy </li></ul><ul><li>Present and Future Creditors- hinder, delay, defraud </li></ul>
    7. 7. Planning Limitations, Cont’d <ul><li>Bankruptcy </li></ul><ul><li>Preferential transfers </li></ul><ul><li>Nondischargeable debts </li></ul><ul><li>Lien stripping </li></ul><ul><li>Ten year claw back on </li></ul><ul><li>Homestead exemption limitation </li></ul><ul><li>Criminal Violations </li></ul><ul><li>RICO Statute </li></ul><ul><li>Bankruptcy Crimes </li></ul><ul><li>Money Laundering </li></ul><ul><li>Conspiracy to Defraud </li></ul><ul><li>Mail and Wire Fraud </li></ul><ul><li>Criminal Fraud </li></ul><ul><li>Defenses </li></ul><ul><li>Legitimate business purpose </li></ul><ul><li>Valid estate planning motivation </li></ul><ul><li>All of the facts/credibility of debtor will be considered by court </li></ul>
    8. 8. Reducing Risk: Insurance <ul><li>Business Insurance Coverage </li></ul><ul><li>Compare premiums/coverage before purchasing </li></ul><ul><li>Retain insurance policies indefinitely </li></ul><ul><li>Give prompt verbal and written notice to the right person </li></ul><ul><li>Enforce the duty to defend </li></ul><ul><li>Rely on another party’s insurance </li></ul><ul><li>Require another party to indemnify </li></ul><ul><li>Factor liability insurance into the insolvency test </li></ul><ul><li>Obtain umbrella coverage </li></ul>
    9. 9. Reducing Risk: Trusts <ul><li>Types of Trusts </li></ul><ul><li>Irrevocable Life Insurance Trust (ILIT) </li></ul><ul><li>Self-Settled and Spendthrift Trust </li></ul><ul><li>Domestic Asset Protection Trust </li></ul><ul><li>Foreign Asset Protection Trust </li></ul>
    10. 10. Irrevocable Life Insurance Trust <ul><li>Protects value from creditors of insured and trust beneficiaries </li></ul><ul><li>Excludes death proceeds from taxation in insured’s estate </li></ul><ul><li>Under certain conditions, may have access to cash values </li></ul><ul><li>Requires annual maintenance to pay premiums </li></ul><ul><li>Requires an independent trustee </li></ul>
    11. 11. Self Settled Trust <ul><li>Creates trust for your benefit, contains provision that prevents creditors from reaching your interest in trust assets </li></ul><ul><li>Usually ineffective to reduce risk except in certain jurisdictions </li></ul><ul><li>Creditors can reach interest of trust maker </li></ul><ul><li>Spendthrift protection does not work when trustor and beneficiary are the same person </li></ul><ul><li>Bankruptcy Code – Bankruptcy trustee can avoid transfer made within 10 years of filing bankruptcy. </li></ul>
    12. 12. Domestic Asset Protection Trusts <ul><li>Selected jurisdictions’ statutes allow a DAPT Irrevocable Trust (11 states) </li></ul><ul><li>Incorporates the respective State’s law </li></ul><ul><li>Discretionary benefits, not in trust maker's estate at death </li></ul><ul><li>Done properly, can create some protection, but this vehicle is not yet well tested in court </li></ul><ul><li>Works best if you reside in a state that allows it by statute and assets can be domiciled in state </li></ul><ul><li>Limited use if bankruptcy is filed within 10 years and there exists actual intent to hinder, delay or defraud </li></ul><ul><li>Some states have better protections than others </li></ul>
    13. 13. Other Considerations for a DAPT <ul><li>Bankruptcy claw-back </li></ul><ul><li>Irrevocability </li></ul><ul><li>Discretionary distributions </li></ul><ul><li>Estate tax and income tax </li></ul><ul><li>Risk of validity challenge </li></ul><ul><li>Fees of creation and maintenance </li></ul><ul><li>Full faith and credit attacks </li></ul><ul><li>Supremacy clause argument – risk from federal courts </li></ul><ul><li>Contract clause concerns </li></ul><ul><li>State of domicile versus state of trust jurisdiction </li></ul><ul><li>Limited existing case law on constitutional issues </li></ul>
    14. 14. Why a Delaware Trust? <ul><li>Specific Benefits </li></ul><ul><li>Carry out wishes of trustor (Maker) </li></ul><ul><li>Protect trustees from liability </li></ul><ul><li>Delaware income tax benefit </li></ul><ul><li>Effective enforcement of trust agreement </li></ul><ul><li>No change in current trust current advisors </li></ul><ul><li>Procedure to change situs of irrevocable trust </li></ul>
    15. 15. Foreign Asset Protection Trust <ul><li>How it works </li></ul><ul><li>Independent Foreign Trustee more protection </li></ul><ul><li>Independent Trust Protector with certain powers </li></ul><ul><li>APT holds overseas money </li></ul><ul><li>99% LP Ownership </li></ul><ul><li>LP holds US money </li></ul><ul><li>LLC 1% GP of LP </li></ul><ul><li>Move only liquid assets </li></ul><ul><li>Less than 50% of net worth </li></ul><ul><li>Reserve assets to pay government or large corporate creditors </li></ul><ul><li>Creditor Attack is Less Likely Because </li></ul><ul><li>Flight (Remove US Assets) </li></ul><ul><li>Flight (Resign as US Trustee) </li></ul><ul><li>Experienced Foreign Trustee, Trust Protector, Counsel </li></ul><ul><li>Practical difficulties to enforce judgment are greater offshore </li></ul>
    16. 16. Key Features of FAPT <ul><li>Arms Length Transaction </li></ul><ul><ul><li>Irrevocable </li></ul></ul><ul><ul><li>Letter of Wishes- non-binding control </li></ul></ul><ul><ul><li>Supervised by Trust Protector </li></ul></ul><ul><ul><li>Cannot be fraudulent conveyance </li></ul></ul><ul><li>Action usually limited to actual creditors who have the burden of proof </li></ul><ul><li>Short statute of limitations </li></ul><ul><li>Does not recognize U.S. judgment </li></ul><ul><li>Legal proceedings brought in foreign jurisdiction </li></ul><ul><li>Difficult to establish jurisdiction if not physically within jurisdiction </li></ul>
    17. 17. Key Features of FAPT (Cont.) <ul><li>Foreign plaintiff often has to post bond or cash to sue </li></ul><ul><li>No disclosure laws for trusts </li></ul><ul><li>Usually enough of a barrier to lead to settlement </li></ul><ul><li>Options to move trust situs </li></ul><ul><li>Limited to amount of creditor claim </li></ul><ul><li>General Rule: Minimum $1,000,000 liquid assets </li></ul><ul><li>Contempt Decisions- Anderson, Lawrence, Brennan </li></ul>
    18. 18. Disadvantages of FAPT <ul><li>Complexity </li></ul><ul><li>Cost (Legal, Appraisals, Maintenance) </li></ul><ul><li>IRS Reporting Obligations </li></ul><ul><li>Ownership Transfer is Irrevocable </li></ul><ul><li>Contempt Cases for not returning assets </li></ul><ul><li>Security of foreign jurisdiction </li></ul>
    19. 19. Limited Use of Asset Protection Trusts for Risk Reduction <ul><li>Valid uses of trusts, but limited for risk reduction </li></ul><ul><li>Bankruptcy 10 year claw back- severe limit in bankruptcy context </li></ul><ul><li>Anderson, Lawrence and Brennan decisions provide risk for both Domestic and Offshore Trusts </li></ul><ul><ul><li>All bets are off if the creditor is the US Government </li></ul></ul><ul><ul><li>Most bets are off if the creditor is a powerful corporation </li></ul></ul><ul><ul><li>In these cases, creditor did not get complete recovery </li></ul></ul><ul><ul><li>Bad facts make bad law </li></ul></ul><ul><ul><li>Six contempt citation cases for ignoring a repatriation order </li></ul></ul><ul><ul><li>No cases of recovery other than voluntary settlement </li></ul></ul><ul><li>Will have to have strong non-protection reasons for the trust </li></ul><ul><li>Prepare an affidavit of solvency before setting up FAPT or DAPT </li></ul><ul><li>Must balance risks with the benefit- probablity of limited value for most high net worth individuals </li></ul><ul><li>Goal : Deter Litigation, Incentive for Early Settlement, Enhance Bargaining Position, Level the Playing Field, Provide Options in Litigation </li></ul>
    20. 20. Choice of Business Entity <ul><li>Factors Driving the Choice </li></ul><ul><li>Management Control & Duties </li></ul><ul><li>Tax Considerations </li></ul><ul><li>Risk Reduction </li></ul><ul><li>Flexibility </li></ul><ul><li>Cost to Form and Operate </li></ul><ul><li>Restrictions on Structure and Capital </li></ul><ul><li>Integration with Estate Plan </li></ul>
    21. 21. Key Terms <ul><li>Inside Liability </li></ul><ul><li>Risk from operation of the business or property itself </li></ul><ul><li>Outside Liability </li></ul><ul><li>Risk from matter not related to the business which exposes the business to liability </li></ul><ul><li>Dangerous Assets </li></ul><ul><li>Assets that have a high potential of creating liability </li></ul><ul><li>Safe Assets </li></ul><ul><li>Assets with a low probability of creating lawsuit liability </li></ul>
    22. 22. Corporations <ul><li>Pros </li></ul><ul><li>Inside out risk reduction </li></ul><ul><li>Graduated tax rates </li></ul><ul><li>Dividends taxed at lower rates </li></ul><ul><li>Medical reimbursement plans </li></ul><ul><li>Cons </li></ul><ul><li>No outside-in risk reduction </li></ul><ul><li>Double tax on sales </li></ul><ul><li>Year end tax planning to zero out earnings </li></ul><ul><li>Unreasonable compensation </li></ul><ul><li>Accumulated tax earnings </li></ul><ul><li>Strict corporate formalities </li></ul><ul><li>Double tax on operating income </li></ul><ul><li>Piercing the Corporate Veil </li></ul>
    23. 23. General Partnership <ul><li>Pros </li></ul><ul><li>Easy to form </li></ul><ul><li>Low cost to form and operate </li></ul><ul><li>Cons </li></ul><ul><li>Unlimited liability for acts of partnership and other partners </li></ul><ul><li>Loss of protection if participate in management </li></ul>
    24. 24. Limited Partnership <ul><li>Purpose </li></ul><ul><li>Holding company--Hold safe assets </li></ul><ul><li>Hold interest in other entities </li></ul><ul><li>Estate planning technique </li></ul><ul><li>Not Used For </li></ul><ul><li>Dangerous assets </li></ul><ul><li>Operations </li></ul><ul><li>Personal residence </li></ul>
    25. 25. Limited Partnership <ul><li>Pros </li></ul><ul><li>Risk reduction </li></ul><ul><li>Pass thru taxation </li></ul><ul><li>Maintain control even if ownership gifted or vested in another person or entity </li></ul><ul><li>Step up basis at death of partner (IRC 754) </li></ul><ul><li>Inexpensive to operate </li></ul><ul><li>Flexible management and economic structures </li></ul><ul><li>Use as a holding company in other entities </li></ul><ul><li>Estate Planning transfer of assets out of estate; discounting; freeze appreciation </li></ul><ul><li>Cons </li></ul><ul><li>Expense of formation </li></ul><ul><li>Charging Order </li></ul><ul><li>Foreclosure of Interest </li></ul>
    26. 26. Limited Liability Company <ul><li>Pros </li></ul><ul><li>Use for rental property </li></ul><ul><li>Insulate dangerous assets </li></ul><ul><li>Operating businesses </li></ul><ul><li>Financial privacy </li></ul><ul><li>Protection for inside liability </li></ul><ul><li>Flexibility-reduced formalities </li></ul><ul><li>Ownership-Trust; Special Purpose Vehicles </li></ul><ul><li>Tax options-pass through </li></ul><ul><li>Estate planning </li></ul><ul><li>Can be set up offshore </li></ul><ul><li>Cons </li></ul><ul><li>Must carefully draft operating agreement </li></ul><ul><li>Business mergers, divisions and reorganizations are more difficult </li></ul><ul><li>Not valuable for single member LLC </li></ul><ul><li>Oregon allows charging order </li></ul>
    27. 27. S Corporation <ul><li>Pros </li></ul><ul><li>Pass thru taxation </li></ul><ul><li>SE tax minimization planning </li></ul><ul><li>Inside-out risk reduction </li></ul><ul><li>Eligible for qualified plans </li></ul><ul><li>Easy for mergers and reorganizations </li></ul><ul><li>Cons </li></ul><ul><li>Restrictions on ownership </li></ul><ul><li>No outside-in risk reduction </li></ul><ul><li>Strict corporate formalities </li></ul>
    28. 28. Risk Reduction <ul><li>Outside Creditors </li></ul><ul><li>Claims outside purview of business entity asserted against owner personally </li></ul><ul><li>Inside Creditors </li></ul><ul><li>Claim against business operation or real estate operated and owned inside a business entity </li></ul><ul><li>Risk Reduction Inside Claims </li></ul><ul><li>C or S Corporation </li></ul><ul><li>LLC </li></ul><ul><li>Protection of Real Estate </li></ul><ul><li>LLC or FLP </li></ul><ul><li>Insurance </li></ul><ul><li>Not held as individual or General Partnership </li></ul>
    29. 29. Use of Multiple Entities <ul><li>Segregate Business Assets </li></ul><ul><li>Dangerous Assets versus Safe Assets </li></ul><ul><li>Real estate in LLC and leased to operating business </li></ul><ul><li>Equipment in LLC and leased to business </li></ul><ul><li>Separate liability entity for different business functions and operations </li></ul><ul><li>Separate entity for trademarks, patents and copyrights </li></ul>
    30. 30. Funding the Entities <ul><li>Owner owns and leases exempt assets to operating entity </li></ul><ul><li>Combination of debt and equity financing </li></ul><ul><li>Encumbering operating entities assets with liens in favor of owner or holding company </li></ul><ul><li>Regular withdrawals of funds generated </li></ul><ul><li>Do not put dangerous and safe assets in same entity </li></ul>
    31. 31. Buy-Sell Agreements <ul><li>Structure: Owner Purchase </li></ul><ul><li>Agreement among business owners to purchase each other’s share –mandatory or optional </li></ul><ul><li>Triggering Events </li></ul><ul><li>Owner’s death </li></ul><ul><li>Retirement </li></ul><ul><li>Disability </li></ul><ul><li>Gift or sell interest </li></ul><ul><li>Bankruptcy </li></ul><ul><li>Divorce </li></ul><ul><li>Leave employment </li></ul><ul><li>Advice </li></ul><ul><li>Avoid making business decisions with partner’s spouse </li></ul><ul><li>Make sure your spouse and family gets your share of value from your business so they can pay the bills </li></ul>
    32. 32. Funding the Buy-Sell Agreement <ul><li>Installment Notes </li></ul><ul><li>Security </li></ul><ul><li>Personal guarantees </li></ul><ul><li>Time needed to accumulate capital-useful for retirement </li></ul><ul><li>Life Insurance </li></ul><ul><li>Regular Review- type of policy; value of corporation; guaranteed insurability option </li></ul><ul><li>No deduction for premiums </li></ul><ul><li>Lack of insurability </li></ul><ul><li>Transfer for value rule applies absent exception </li></ul><ul><li>Charitable Remainder Trust </li></ul><ul><li>Asset value low </li></ul><ul><li>Owner receives income for life; remainder to charity </li></ul><ul><li>Trust does not pay capital gains tax </li></ul>
    33. 33. Stock Redemption <ul><li>Structure: Sale to Entity </li></ul><ul><li>Corporation redeems the shares of a deceased shareholder at death/disability </li></ul><ul><li>Advantages </li></ul><ul><li>Simplicity of one life insurance policy per shareholder </li></ul><ul><li>Premium costs are allocated to the shareholders according to their percentage ownership </li></ul><ul><li>Policy protected from shareholders’ creditors </li></ul>
    34. 34. Stock Redemption <ul><li>Disadvantages </li></ul><ul><li>Loss of step up basis surviving shareholders </li></ul><ul><li>Insurance polices subject to attachment by business creditors </li></ul><ul><li>C Corp death proceeds may be subject to AMT </li></ul><ul><li>If policies overfunded to provide non-qualified retirement benefits, benefits are taxable </li></ul><ul><li>Proceeds increase earnings, redemption decrease in earnings for dividends </li></ul><ul><li>Estate tax issues if deceased shareholder has control-ownership interest results in inclusion in estate </li></ul>
    35. 35. Cross Purchase <ul><li>Structure: Purchase from Decedent’s Estate </li></ul><ul><li>Surviving owners purchase deceased member shares from estate </li></ul><ul><li>Advantages </li></ul><ul><li>Individuals own policies, receive death benefit, family of deceased has stepped up basis by buying the stock directly </li></ul><ul><li>Life Insurance proceeds to surviving owners not subject to income tax; tax basis is purchase price </li></ul><ul><li>Estate tax—life insurance proceeds not included in estate of deceased shareholder </li></ul><ul><li>Wait and see approach allows decision on source of funds to buy stock </li></ul><ul><li>Policies protected from corporate creditors </li></ul><ul><li>Proceeds of policy not subject to AMT </li></ul>
    36. 36. Cross Purchases <ul><li>Disadvantages </li></ul><ul><li>Difficult to administer if numerous shareholders buying a plan for each other </li></ul><ul><li>Number of policies expand if disability insurance is purchased </li></ul><ul><li>Age or insurability creates disparity in premiums </li></ul><ul><li>Subject to attachment by shareholders’ creditors </li></ul><ul><li>Shareholder may fail to pay premiums </li></ul><ul><li>May fail to pay benefits pursuant to buy sell agreement </li></ul>
    37. 37. Valuation <ul><li>Book Value </li></ul><ul><li>Recorded in accounting records </li></ul><ul><li>Snapshot of assets/liabilities </li></ul><ul><li>No appraisal </li></ul><ul><li>Fair Market Value </li></ul><ul><li>Willing buyer-willing seller </li></ul><ul><li>Requires appraisal </li></ul><ul><li>Parties can agree on value if provided in agreement </li></ul><ul><li>Formula Approach </li></ul><ul><li>Book value plus percentage </li></ul><ul><li>Capitalization of future earnings </li></ul><ul><li>Method can be different for different triggers </li></ul>
    38. 38. Insurance Trust Agreement <ul><li>Structure: Purchase Policies with Trust </li></ul><ul><li>Policies owned by an irrevocable trust </li></ul><ul><li>Advantages </li></ul><ul><li>Simplicity of one policy </li></ul><ul><li>Premiums based on ownership interest </li></ul><ul><li>Assures compliance with buy-sell </li></ul><ul><li>Not included in estate of deceased shareholder </li></ul><ul><li>Disadvantages </li></ul><ul><li>Potential for income tax under transfer for value rules </li></ul>
    39. 39. Issues When Withdrawing Funds: Fraud Potential <ul><li>Fraud Restrictions </li></ul><ul><li>Covers all transactions of business with owners </li></ul><ul><li>Must have intent to defraud creditors </li></ul><ul><ul><li>Motive </li></ul></ul><ul><ul><li>Timing </li></ul></ul><ul><ul><li>Insolvency at time </li></ul></ul><ul><ul><li>Adequate consideration </li></ul></ul><ul><ul><li>Substantially all the debtor’s assets </li></ul></ul><ul><ul><li>Concealment </li></ul></ul><ul><ul><li>Transfer to lien holder for insider </li></ul></ul><ul><li>Constructive Fraud Restrictions </li></ul><ul><li>Receives less than full value </li></ul><ul><li>Transferor is insolvent –cash flow or balance sheet test </li></ul><ul><li>Transfer to owner for return value-avoids constructive fraud </li></ul><ul><li>Statutory Fraud Limits </li></ul><ul><li>Less than full value </li></ul><ul><li>Restrictive Balance Sheet test </li></ul><ul><li>Cash Flow Test </li></ul>
    40. 40. Issues When Withdrawing Funds: Withdrawl Methods <ul><li>Dividends </li></ul><ul><li>Statutory Test </li></ul><ul><li>Earned Surplus </li></ul><ul><li>Delaware less restrictive test </li></ul><ul><li>Salary </li></ul><ul><li>Reasonable compensation </li></ul><ul><li>Regular and in Writing </li></ul><ul><li>All subject to self employment tax </li></ul><ul><li>Not paid because of ownership interest </li></ul><ul><li>Loans and Leases </li></ul><ul><li>Business owner secured creditor </li></ul><ul><li>Courts held legitimate business expenses </li></ul><ul><li>Exempt self employment taxes if multi-owner </li></ul><ul><li>Contractual Obligation of Guaranteed Payments </li></ul><ul><li>Does not reduce tax basis in LLC </li></ul><ul><li>Make to owners without reference to ownership interest </li></ul><ul><li>Sales of Accounts Receivables </li></ul><ul><li>Sell to holding company </li></ul><ul><li>Operating entity withdraws for salary, leases, loans and operating expenses </li></ul>
    41. 41. Transferring Business Interest to the Family <ul><li>LLC Interest </li></ul><ul><li>Voting and Non-Voting Interest </li></ul><ul><li>Transfer Value without Transferring Control </li></ul><ul><li>Discounted Value </li></ul><ul><li>Lack of Control </li></ul><ul><li>Lack of Marketability </li></ul><ul><li>Appraisal </li></ul><ul><li>Tax Free Gifts </li></ul><ul><li>Annual Gifting </li></ul><ul><li>Gift Splitting for Married Couples </li></ul><ul><li>Lifetime Exemption </li></ul><ul><li>Issues for the Business Owner </li></ul><ul><li>Planning methods under IRS scrutiny </li></ul><ul><li>Children receive share on liquidation </li></ul><ul><li>Still must plan for transfer of control </li></ul><ul><li>Must be a capital income producing business, not service of parent or taxed to parent </li></ul><ul><li>Only appropriate to family owned business </li></ul>
    42. 42. Risk Reduction: What Probably Won’t Work <ul><li>Revocable Living Trusts </li></ul><ul><li>Nevada Corporation alone </li></ul><ul><li>Leaving no equity anywhere </li></ul><ul><li>Giving it away (but not really) </li></ul><ul><li>Lying </li></ul><ul><li>Some types of Trusts </li></ul><ul><li>Transferring assets after claim </li></ul>
    43. 43. Risk Reduction: What Might Work <ul><li>Limited liability companies </li></ul><ul><li>Limited partnerships </li></ul><ul><li>Multiple entities </li></ul><ul><li>Buy-sell agreements </li></ul><ul><li>Statutory exemptions </li></ul><ul><li>Life insurance/ Life insurance trusts </li></ul><ul><li>Personal residence trusts </li></ul><ul><li>Domestic Asset Protection Trust (Limited-Non Oregon) </li></ul><ul><li>Offshore Asset Protection Trusts (Limited) </li></ul><ul><li>Divide and conquer- properly title assets </li></ul><ul><li>Maintain adequate insurance </li></ul><ul><li>Avoid general partnerships </li></ul><ul><li>Planning when the seas are calm </li></ul><ul><li>Planning done for non-asset protection reasons </li></ul><ul><li>Don’t use a Ferrari to cut the lawn </li></ul>
    44. 44. Questions? <ul><li>Let me be a resource to you and your clients. </li></ul><ul><li>Russ Pike </li></ul><ul><li>[email_address] </li></ul><ul><li>503-364-2281 </li></ul><ul><li>www.shermlaw.com </li></ul><ul><li>Also find us on LinkedIn or facebook </li></ul>

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