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Estate Planning and Succession Planning for Family and Closely Held Businesses


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What's going to happen to your family business after you die? Business owners must plan for succession or transition for when that time comes, and should be included in your estate and succession plans.
Today, attorney Mark Kellogg shared his insight with the Greater Lansing Estate Planning Council, at a meeting on estate and succession planning for family and closely-held businesses. His presentation included a look at:
• Different Types of Business Entities
• Joint Ownership of Personal Property
• Gift and Estate Tax Exclusion
• Key Components to Consider for Succession Planning
• Estate Planning Considerations
• Family Limited Liability Companies

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Estate Planning and Succession Planning for Family and Closely Held Businesses

  4. 4. Estate Planning for Family and Closely Held Businesses  To many, estate planning consists of deciding how property should be distributed at death  BUT, it also includes plans and techniques to build your estate during life –  type of property to own  form of ownership; and  organization and operations of the business including succession planning – which may include passing the business on to the next generation
  5. 5. Types of Business Entities  Corporation  C – Corporation Subject to Michigan Business Tax  Subchapter S Corporation (or S- Corporation) Pass-through entity Restriction on Type of Shareholders (QSST)
  6. 6. Types of Business Entities  Limited Liability Company  Entity of Choice (but consider options)  Can also be formed as: C-Corporation S-Corporation Disregarded Entity (Single Member LLC)
  7. 7. Types of Business Entities  Limited Liability Company  Pass-through entity (unless C- Corporation)  Consider Self-employment tax issues v. S-Corporation; Employee v. Member / Shareholder  C-Corporation, S-Corporation, Disregarded Entity (Single Member LLC)
  8. 8. Types of Business Entities  Limited Partnership (consider liability of General Partner)  General Partnership (very limited use–partners typically entities)  Sole Proprietorship
  9. 9. Joint Ownership of Personal Property  Stock (MCL 557.151) and a membership interest in a limited liability company (MCL 450.4504) may be held by a husband and wife in joint tenancy in the same manner and subject to the same restrictions, consequences and conditions that apply to the ownership of real estate held jointly by a husband and wife under Michigan law (tenancy by the entireties) – including with full right of survivorship.
  10. 10. Gift and Estate Tax Exclusion (Exemption) Amount and Portability  $5,430,000 for 2015 (indexed annually for inflation)  Portability  Helps small businesses in gift and estate tax planning
  11. 11. ESTATE/SUCCESSION PLANNING --WHERE DO YOU START? Do you want to transfer your business as a “business” or simply as a group of
  12. 12.   If as a business: You will need both a business transition (succession) plan and an estate plan  If assets: You will only need an estate plan WHERE DO YOU START?
  13. 13. What’s the Difference?
  14. 14. GOALS: Things to Consider  Retirement lifestyle (money needed)  Non-business heirs  Residence  Lifestyle (money needed)  Growth of Business  Attitude toward debt  Ownership vs. renting  Family time vs. work OLDERGENERATION YOUNGER GENERATION
  15. 15. Things to Consider: Financial Viability  Business Income  Amount  Source  Business Debt Structure  Long-term v. short-term loans  Principal payments/Interest Rate  Source  Family Living Cost  Retiring Family  Business Family (younger generation)  Insurance
  16. 16. Planning for the future: Succession Plan  Are parents (business owner) ready for a partner?  How committed is the child to the business?  Is the business large enough?  Do you have a common vision of your future together?  Can you live and work together?  How many children in the business?  Roles of children if more than one?  Are the non-business children supportive?
  17. 17. Components to Transfer
  18. 18. Methods to Consider: Gift  Possible Gift Tax Implications  Annual/Serial Gifting (2015 Annual Exclusion $14,000)  Gift Planning Sales Consider financing options Succession Planning: Ownership
  19. 19. Family Limited Liability Company  In the context of estate planning for a family, an LLC is a company owned among family members created to allow joint ownership of family/business owned assets (such as real estate, business assets, equipment, stock (not S-corporation stock)).  Benefits to implementing an LLC as part of estate plan:  To “fractionalize” interests in property for the purpose of carrying out a gifting strategy  To seek “discounts” on life-time gifts made and on the transfer of a member’s remaining interest in the LLC at death (discounts for lack of control and lack of marketability may total up to 30% to 40%).
  20. 20. Methods to Consider (cont.): Timeline  Specifically outlined and followed  Gradual change in ownership Inheritance / Will Consider non-business children (heirs)  Sufficient non-business assets/insurance Succession Planning: Ownership
  21. 21. Succession Planning: Management  How will management be divided?  Enterprise  Whole business  Business Responsibilities/Roles/Activities  Timeline for management transition  Training/Learning or Testing Phase  Completion/phase-out date  Parent/child relationship vs. business partner
  22. 22. Succession Planning: Income/Labor  How will income and labor be split? Enterprise Shares/Ownership Wage Combination  Timeline for split of income and labor  Job description
  23. 23. Planning for the Future: Retirement Plan  Timeline of business involvement by family  Considerations of management, labor, ownership  Where will money come from?  Considerations of income  Where will you live?  How will you account for non-business children/heirs?  Use of Insurance/sufficient non-business assets  Will/Trust is contingency plan (coordinate succession plan with estate plan)
  24. 24. RETIREMENT INCOME OPTIONS  Operating child/heir can rent equipment/real estate from parents (long- term lease)  Purchase of Business  Rental payments or business purchase proceeds can finance retirement income stream
  25. 25. Buy-Sell Agreement  Buy-sell agreement is essential if gifting and/or selling business interests to family members/key employees  Provides buy-out provisions and guarantees a market for a deceased, disabled or withdrawing stockholder’s/owner’s shares/interests  Restricts the transfer of the business interest and guarantees that control over the business remains in the hands of the surviving or remaining stockholders/owners  Fix the value of the business for estate and gift
  26. 26. Concern forMinimizing TransferTaxes on Transferof Business- 1. Utilize annual exclusion gifts; gift tax exemption; and valuation discounts 2. Make gifts in trust to protect beneficiaries from creditors, ex-spouses and estate taxes 3. If sale required for business owner’s retirement needs, consider:  Sale to Defective Grantor Trust  Grantor Retained Annuity Trust (GRAT)  Private Annuity  Self-Cancelling Installment Note (SCIN)
  27. 27. Sale to Defective Grantor Trust  If business owner chooses to sell the business to younger generation with owner receiving installment note as payment  Sale to a Trust of which the business owner (senior generation) is the owner for income tax purposes  No capital gains tax  Balance income needs of business owner with the transfer tax consequences of the terms of Note  For example, the balance of the note will be included in the estate of business owner for estate tax purposes  Typically not appropriate for C-Corporations (because of double taxation with dividends)  Note should contain a self-cancelling provision
  28. 28. Sale for Private Annuity  Sell business interests to the junior generation in exchange for a private annuity  The private annuity will provide for periodic payments to business owner for life (or the shorter of life or a term of years)  Sale for private annuity will provide source of income that can be extended for life of business owner (unlike sale to grantor trust)  This technique is best suited for transfer of a business that produces significant income  Not typically appropriate for a C-Corporation because it can result in double taxation of corporate dividends  From the family’s overall tax standpoint, may have adverse transfer tax consequences if the business owner outlives his or her life expectancy (may freeze value at time of sale)  Might be short-lived opportunity-2006 proposed regulations would require recognition of income at time of exchange
  29. 29. Grantor Retained Annuity Trust (“GRAT”)  Transfer of business interests to GRAT  Retain the right to receive an annuity payment back from the GRAT for each year of its term  Difference between the present value of the annuity payments and the initial transfer to the GRAT is a gift for gift tax purposes (GRAT may be “zeroed out”)  Better suited for the transfer of business interests if the interests generate sufficient income to satisfy the annuity payments in cash or other liquid assets  Business owner may have to consider need for alternative income sources once the GRAT terminates and the annuity payments end
  30. 30. Self-cancelling Installment Note (SCIN)  Although advantage of intra-family installment sale is that it improves the liquidity of seller’s estate and provides income to seller of business, a disadvantage is that the present value of unpaid installments is included in seller’s gross estate  SOLUTION: Self-cancelling installment note  Structured properly – unpaid balance not in estate  Hybrid of installment sale and private annuity  Buyer must pay risk premium in exchange for cancellation feature
  31. 31. How is succession accomplished?  Regular business meetings during entire transition period  Talk about it, then write it down  Share with non-business family members  Surprises cause problems!  Work with your planning team – Attorney, CPA, Investment Advisor, Insurance Agent COMMUNICATION COMMUNICATION
  32. 32. TOP TEN WAYS TO SABOTAGE BUSINESS TRANSITION PLANS 1. Procrastinate  Don’t write a will or transfer plan. Let your children worry about it after you are gone. 2. Avoid planning or making decisions (you will be gone anyway) 3. Don’t discuss the subject of estate planning or business succession Keep information from the next generation. This is a sure way to increase family conflict.
  33. 33. TOP TEN WAYS TO SABOTAGE TRANSITION PLANS 4. Blame others for problems. 5. Do all you can to block the younger generation from any involvement in goal-setting or decision making. 6. Refuse to listen to other family members’ viewpoints. 7. Hold on to total control of the family business.
  34. 34. TOP TEN WAYS TO SABOTAGE TRANSITION PLANS 8. Assume others know what you want. Avoid discussing your wishes about transfer with family members. 9. Make sure all your sense of worth, your identity, and life’s meaning come solely from the business. Resist transferring to the next generation. This way they have the least influence and the most stress. 10. Pay no attention to wake-up calls, like a work- related accident, illness, death, or major choice point by a child or children (i.e., do they want to join the “family business”).
  35. 35. KEYS TO SUCCESS FOR ESTATE PLANNING/SUCCESSION PLANNING 1. Strengthen family relationships 2. Communicate and improve communication skills if needed 3. Recognize individual differences 4. Management participation = learning 5. Promote and encourage decision making 6. Demonstrate a make it work attitude 7. Develop written estate and succession plans/agreements 8. Fit the agreements to the situation 9. Update the succession plan and/or estate plan as needed 10. Work with your advisor team (attorney CPA, investment
  37. 37. Additional offices located in: Detroit and Grand Rapids Fraser Trebilcock Davis & Dunlap, P.C. 124 W. Allegan Street, Suite 1000 Lansing, Michigan 48933 Phone: (517) 482-5800 Fax: (517) 482-0887 Mark E. Kellogg, J.D., CPA 517-377-0890 QUESTIONS?
  38. 38. Disclaimer These materials are not intended to be legal advice, nor are they intended to be a substitute for legal services from a competent professional. These materials are for educational purposes only.