Business Owner Insurance Planning By Mark Simon


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  • As a business owner, you have special areas of interest with regard to fringe benefit planning.
  • You can separate fringe benefit planning into two categories: (1) benefits for you and selected key people, and (2) benefits for all of your employees.
  • Today we are going to discuss many types of benefits that are designed for you and your key people.
  • As well as certain benefits that are geared toward all employees.
  • What is an ideal fringe benefit? From a tax standpoint, the business wants to be able to currently deduct the cost of the benefit while postponing to a later date any tax consequences to the employee.
  • Let’s look at what a tax-deductible benefit really costs the corporation. If your corporation is in a 34% tax bracket, then every dollar of benefit costs only 66 cents. Alternatively, if your business is in a 15% tax bracket, the same dollar of benefit has an after-tax cost of 85 cents.
  • Tax-deductibility is only one factor to be considered. It is important to remember that a tax-deductible corporate dollar still involves an after-tax cost to the business. Also, a tax-deductible corporate dollar is of less importance to a corporation in a low tax bracket as compared to a corporation in a higher tax bracket.
  • With this in mind, let’s look at fringe benefit planning from another perspective. It is financially advantageous to shift personal nondeductible expenses to the corporation, where possible. A benefit that releases an employee of a personal expense that is not deductible makes for an ideal fringe benefit if the employer can deduct the expense.
  • Of course, income tax rates affect business planning. Tax brackets play a big part in determining what is the most cost-effective method of providing benefits.
  • A necessary starting point is examining the relative tax bracket of your business as opposed to your personal tax bracket. Depending on which bracket is higher or lower will have a big impact on benefit planning.
  • Of course, we would always like to be able to deduct all of the benefit costs, but the IRS isn’t always so cooperative. The two key areas of concern are the deductibility of benefits and the control of the benefit values.
  • Sometimes we can’t get everything we want so we are forced to make a tough choice. If you had to choose, what would it be: a tax deduction or control of benefit values? We’ll come back to this issue later when we look at specific types of benefits.
  • Before we get too far along in our discussion of benefit planning, it is important to pause and discuss the various types of business organizations out there. The type of business organization you have chosen will affect your benefit planning. The six most common types of organization are listed here. What type is your business?
  • Let’s review some basics. The simplest form of organization is the sole proprietorship. A business owned entirely by one person, no document is needed to establish it, and it can last as long as the sole proprietor lives. The owner is personally liable for all debts and records business income and expenses on his or her own income tax return.
  • A partnership, on the other hand, is a business with two or more owners that can be created by either oral or written agreement. A partnership can last as long as all the partners are living and the partners, as a group, are given management responsibility. Each partner is personally liable for all business debts. With regard to income taxes, the partnership entity files an informational return, but income is taxed to the partners personally.
  • There are several different types of corporations, but all corporations have some features that are constant. Corporations are separate legal entities that are created by filing articles of incorporation with the state. A unique corporate feature is that the business continues after the shareholder’s death. Ultimate management responsibility rests with the Board of Directors, which is elected by the shareholders. A key feature is that liability is limited to the corporation’s assets – the shareholders’ assets are not up for grabs. As a separate entity, the corporation pays tax on its net income. Reasonable salaries for shareholder employees and employees are deductible by the corporation. A corporation survives the death of a shareholder and shares of stock can easily be transferred during life or at the death of a shareholder. Corporations are not without disadvantages. There are costs associated with establishing a corporation as well as the need to observe corporate formalities. Also, if dividends are paid, there is double taxation of earnings (at the corporate level and when dividends are paid to shareholders).
  • But many business owners have elected “S” corporation status. What does this mean? “S” corporations enjoy non-tax corporate attributes. An “S” corporation election allows a business to make use of the non-tax advantages of a corporation without suffering some of the income tax disadvantages.
  • An “S” corporation is taxed like a partnership. All profits and losses flow through the corporation to the shareholders personally. This type of corporation can avoid double taxation of earnings since taxes are not imposed on the corporate entity. But it is important to keep in mind that the shareholders are taxed on all profits of the business whether or not they take the money out of the corporation. When individual tax rates are lower than corporate rates, “S” corporations are very popular.
  • Another variety of corporation is the professional corporation which describes corporate associations of physicians, accountants, lawyers and other professional people (i.e., engineers, architects, consultants). These corporations are subject to a flat corporate tax rate (currently set at 35%) and as such are not given the benefit of graduated tax rates. Tax deductibility of employee benefits is available as long as professionals operate their practices as tax-paying corporations.
  • A natural counterpart to S corporations, limited liability companies (LLCs) are designed to provide the liability protection afforded to shareholders in a corporation, combined with the advantages of partnership taxation. LLCs, a relatively new type of business entity, are now permitted by all states and are becoming the entity of choice for many small business owners. LLCs are governed at the state level; therefore, particular attention should be given to the laws of your state. Potential liability for an LLC is limited to the amount of property contributed. Also, LLCs are not burdened by ownership restrictions applicable to S corporations concerning the maximum number of shareholders (100) and the types of entities allowed to be shareholders (corporations, partnerships, etc…). Unlike S corporations, LLCs may have more than one class of stock and preferred allocations of profits and losses are allowed. LLC law is uncertain in many areas, making planning a bit precarious. As with other pass-through business entities, LLCs taxed as partnerships lack a business tax bracket to provide flexible financial planning.
  • Have you always operated your business in its present business organization? Have you recently changed business organization or are you considering such a change now? Choosing the best form of organization depends on many factors, and these factors may change over time, as your business changes. Corporations enjoy limited liability, business continuity and several tax and fringe benefit advantages.
  • Now that we have a basic understanding of the different types of business entities, let’s take a look at some business planning strategies. You have probably insured your business against the loss of buildings and equipment. But what about your firm’s most valuable assets – your key people? The death of a key person will often have a devastating effect on the future of your business.
  • Who is a key person? A key person is the asset that holds the business together. When this human asset fails, the business falters. Key person insurance indemnifies your business for the loss of skill and experience. Think about the “key” characteristics listed on the screen. How many of your employees come to mind? Most businesses have a few employees crucial to the continued financial health and success of an organization.
  • The death of a key person can cause many problems for your business.
  • How does this concept work? The business sets the value of the key person and purchases life insurance on the life of the key person. The business is the premium payor, owner and beneficiary of the policy. If the key person dies, life insurance proceeds are paid directly to the business. The company can then use the proceeds to offset losses in sales, productivity, credit, morale or cost of replacement. The premiums are not deductible, but the proceeds are received free of regular income tax under current tax law (some C corporations may be subject to the alternative minimum tax).
  • Make a corporate resolution to fully protect your business. I would be glad to provide you with a sample corporate resolution you can use to document a key employee’s value to your business.
  • Now we are going to turn our attention to executive fringe benefits. These are selective benefits for you and your top people. Do you remember when I spoke of making a choice between being able to deduct the cost of a benefit or controlling the plan values? Well now is the time to further explore this issue.
  • In selecting executive benefits for your key people, control of benefit values can be an important issue. If control is important to you, then you should consider the top of the scale. If control isn’t that important, consider the bottom. Of course, for your own personal benefits, control of benefit values is not as important since you own and control the business. In this case, taxation may be the deciding factor.
  • If maximum control is your primary concern, then a supplemental executive retirement plan (SERP) may be the right executive fringe benefit for your key people. SERPs place “golden handcuffs on key people making benefits too valuable to leave behind. SERPs are sometimes referred to as “deferred compensation” plans.
  • (review definition)
  • Are there any key people whom you would like to tie to the company by promising retirement benefits that they would forfeit if they left your company? SERPs can provide benefits where there is no pension plan in place or serve as a supplement to existing pension benefits. By reducing the executive’s need to invest after-tax dollars in personal life insurance and retirement programs, you can secure the retention of your key people.
  • How does a SERP work? The corporation makes an agreement with the employee, promising retirement and death benefits if the employee stays with the company up to retirement. The corporation then acquires a life insurance policy on the life of the executive. The business is the owner, beneficiary and premium payor of the policy (the same as with a key person policy). If the employee dies prior to retirement, the proceeds are paid to the corporation so that it can pay the promised benefits to the executive’s heirs. If the employee makes it to retirement, he or she is paid compensation for a set period of time according to the SERP agreement.
  • In addition to the golden-handcuff feature of the plan, there are many advantages of a SERP. The corporation can provide flexible benefits for employees of their choice. The corporation can arrange to recover all of its costs without complying with administration hassles.
  • Let’s take a minute and review the tax consequences of a SERP. The corporation can deduct compensation payments when paid to the employee and the employee is not taxed on payments until received.
  • How do you account for this type of plan? The life insurance policy is carried as an asset on the company’s books since it owns and controls the values. The promise to pay benefits is carried as a company liability.
  • Now we are going to shift gears somewhat and explore another type of executive benefit. Would you be interested in providing any of your key people with death benefit protection where the business would be reimbursed for its costs? Split-dollar is the name of such a plan. Split-dollar insurance does not refer to a type of policy, but to a method of paying for the policy.
  • Using the split-dollar concept, a business and an employee can arrange to split the ownership, benefits and premium-paying responsibility of a life insurance policy.
  • When should you consider a split-dollar plan? Any of these situations lend themselves to split-dollar. Fringe benefit: Since the employer can pick and choose those employees who will benefit, split-dollar can be used to attract and retain key executives. Estate liquidity: When an executive has an estate tax problem, the executive may want to consider removing life insurance from his or her estate. A popular method of reducing estate taxes is the irrevocable life insurance trust. Split-dollar arrangements can be used in this situation to reduce the executive’s out-of-pocket costs. Buy-sell planning: In some instances, the premiums for buy-sell policies may be too costly for shareholders. A split-dollar arrangement can be used in conjunction with the buy-sell plan to assist the shareholders in purchasing adequate insurance. Group term replacement: Due to the anti-discrimination rules, the amounts of group term insurance on key people may be limited. Split-dollar plans can be used to increase benefits.
  • Split-dollar can increase a company’s ability to attract and retain valued employees by assisting them at a time when protection may be most needed. The plan has little or no net cost to the executive and the company recovers its costs.
  • The elements of a permanent life insurance policy that can be shared or “split” between two parties are ownership, cash value, beneficiary and premium. The share of each element will depend on the goals of the parties involved. For example, in a business setting, the employer typically pays most or all of the premiums, has ownership rights in some or all of the policy cash value during the employee’s lifetime and receives a specified amount of the proceeds. The employee pays the remaining premium, if any, and designates the beneficiary who receives the remainder of the proceeds.
  • At the death of the key employee, the employer gets its money back from the proceeds of the policy (assuming the split-dollar agreement is still in force) and the personal beneficiary of the employee receives the balance of the proceeds.
  • The strength of split-dollar lies in its flexibility. Split-dollar can be designed as either a “non-equity” plan or as a “loan” plan. Non-Equity: With a non-equity plan, the employer is typically the policy owner. The employee’s cost is the annual term value of their share of the death benefit which must be reported on their annual income tax return. The employer owns the entire policy cash value and receives death benefits equal to the greater of its premiums paid or the entire policy cash value. The plan can be designed for plan termination (and cost recovery) at any time but is typically ended at the employee's death or retirement. Loan Plan: With a loan plan, the employee is treated as the policy owner and has an interest in the policy cash value exceeding the employer's premiums paid (also know as a policy’s “equity”). The employee’s cost is determined by calculating annual imputed interest income applying a federal government interest rate to the cumulative premiums paid. At death, retirement or termination of the plan (so-called “rollout”), the employer is entitled to recovery its total premiums paid.
  • In many cases, a split-dollar arrangement will be terminated at the time of the employee’s retirement. This termination of the plan is by mutual agreement and both parties benefit from the undoing of the arrangement, which is commonly called “a rollout.” The employer gets its money back and the employee walks away with the remainder of the policy – free and clear of the assignment.
  • What are the tax consequences of this arrangement? The employer doesn’t deduct the premium payments because it typically owns the cash value of the policy and eventually gets its money back. The employee has a tax obligation based on age, amount of coverage and any policy cash values received. In a relatively short time we’ve managed to see that split-dollar is a way of using life insurance to help solve the needs of both employer and employee.
  • We just finished discussing an excellent way for C corporation owners to provide for life insurance. But what S corporations? Some plans (like split-dollar insurance) just don’t work with S corporations because when you elect S corporation status you lose the tax leverage of having your corporation as a separate taxable entity. But, don’t give up, there is a personal retirement plan for you. Let me ask you a few questions.
  • Would you be interested in retirement cash flow that can be accessed on a tax-advantaged basis?
  • Would you be interested in a plan where values grow tax-deferred?
  • Would you be interested in a plan that allows you to exclude all of your employees?
  • Would you be interested in a plan with relatively few government rules or regulations?
  • If you answered “yes” to these questions – and who wouldn’t – then there is a plan for you. I can design plan just for you, utilizing the advantages of permanent life insurance.
  • Cash value build-up in a traditional life policy can provide significant and reliable retirement income to supplement your Social Security and qualified plan benefits.
  • Whatever you do, make sure you have your retirement needs covered. An insurance plan can be just what you need.
  • Now let’s focus on your key employees and executives. You can provide the same retirement benefits for your selected key people by implementing an Executive Bonus Plan.
  • Here’s how an executive bonus plan works. Your business purchases an insurance policy on the life of each participant you select. Each premium payment is a tax deductible business expense and is taxed to the executive as income. The executive is the owner of the policy and names his/her policy beneficiaries. The policy cash values accumulate on a tax-deferred basis and can be accessed as needs arise (such as for college funding or for retirement income). If properly structured, the policy values are accessed on a tax-advantaged basis and are free from the claims of the executive’s creditors (subject to state specific laws). In the event of the executive’s death, policy death benefits are paid income tax-free to the executive’s heirs (and can be earmarked to pay estate settlement costs such as estate taxes and /or final expenses).
  • Let’s take a minute and review the tax consequences of a deferred compensation plan. The corporation can deduct compensation payments when paid to the employee and the employee is not taxed on payments until received.
  • If you prefer to have more control over the plan, consider custodial executive bonus. (Review slide) As you can see, custodial executive bonus adds more employer control, not only over access to cash values but also over other important policy decisions.
  • Let’s shift gears again and focus on you and your business instead of fringe benefits. What would happen to your business if you suddenly died or became disabled? What would your reaction be if your business partner suddenly died or became disabled? How many months do you want to do all the work, but not be entitled to all the profits? Buy-sell planning is an effective way to provide for an orderly change of ownership when a business owner dies or becomes disabled.
  • Typically, there are three events that trigger a need for a buy-sell plan: death, disability or retirement of a business owner. A buy-sell agreement states the plan for disposition of a business among the various business owners at the time of any of these events. For simplicity’s sake, we will focus today primarily on buy-sell agreements triggered at death. I will be glad, however, to answer questions regarding disability or retirement buy-sells.
  • Why should you care about buy-sell planning? Because if you don’t make preparations for the successful continuity of your business, its value will be gone.
  • What are the advantages of having a funded buy-sell agreement? Well, proper planning can guarantee both a buyer and a mutually acceptable price for the business, thereby providing for an orderly transfer of the business. Also, a buy-sell agreement can provide a binding value of the business for federal estate taxes. Finally, proper planning provides for certainty – certainty that things will go the way you planned.
  • What are the issues that need to be addressed by the business owners in a buy-sell agreement? You want: (1) top dollar for your share of the business, (2) prompt settlement, (3) fixed estate tax value, and (4) relief to your family from business worries.
  • The other owners are looking for different things. They are interested in getting full control of the business as soon as possible for as little money as possible. Also, the surviving owners are going to want to avoid any interference from your heirs. Further, the survivors want a smooth and prompt transfer so as not to interrupt the flow of business or credit.
  • Don’t ignore the issues of buy-sell planning. Lack of planning may pit your family against the other business owners. They won’t have you to help them in negotiations if you don’t make a plan. An agreement favorable to all parties can be most easily and fairly drafted prior to a crisis.
  • Many business owners realize the importance of adopting a buy-sell agreement, and do so, but fail to follow through by making provisions for funding. An agreement obligating you to buy your partner’s business interest at his or her death will be a big burden on you if you don’t take the steps to make funding available in the future.
  • What methods of funding a buy-sell agreement are available? One option is the personal funds of buyers. Most business owners, however, do not want to keep large sums of liquid assets on hand. Instead, they prefer to have their money working in their business. A sinking fund in the business is another option, but this type of fund is inadequate if death is premature and the time of need is uncertain. Borrowed funds aren’t always an option because the loss of a key person may impair the credit of the business and its other owners. Installment payments to heirs by buyers aren’t always possible. The business may fail and the payments may stop. Also, the principal and interest payments may be too burdensome. Life insurance owned by the buyer of the business can be an excellent funding method.
  • Life insurance is an ideal funding vehicle for buy-sell agreements. A life insurance policy is designed to provide proceeds at the exact time they are needed – at the business owner’s death. Policy proceeds can be free from income tax which is a big advantage. Cash values of policies can be used if a buy-out is desired at retirement or disability of an owner. Also, depending on age and health of the insured, life insurance makes the most economical method of providing coverage, while at the same time, strengthening the business’s credit position.
  • There are two types of buy-sell agreements for corporations; one is called a cross-purchase plan and the other is called a stock redemption plan or entity agreement. Let’s examine how a cross-purchase plan works.
  • A and B are equal owners of a business worth $500,000 with a cross-purchase buy-sell agreement. A owns a $250,000 policy on B and B owns a $250,000 policy on A. In our example B dies. Since A owns an insurance policy on B’s life, A will receive $250,000 of proceeds from the insurance company. A uses these income-tax free dollars to buy B’s interest in the business from B’s estate. A is now 100% owner of the business and B’s heirs have received full value for B’s share of the business.
  • A and B are equal owners of a business worth $500,000 with a cross-purchase buy-sell agreement. A owns a $250,000 policy on B and B owns a $250,000 policy on A. In our example B dies. Since A owns an insurance policy on B’s life, A will receive $250,000 of proceeds from the insurance company. A uses these income-tax free dollars to buy B’s interest in the business from B’s estate. A is now 100% owner of the business and B’s heirs have received full value for B’s share of the business.
  • In order to fund a buy-sell agreement, you need to determine the value of your business. There are many technical formulas out there that people refer to, but often, the best measure of the value of your business is what you would be willing to sell it for today.
  • Given all these factors, it is clear to see that without an agreement, neither side may have their objectives satisfied. Any way you look at it, a funded buy-sell agreement is a win-win proposition.
  • A very important issue for all business owners is the need for disability income insurance.
  • While most of you insure your lives and material assets, many overlook the need to protect your most valuable asset – your ability to earn an income. According to CIDA statistics, the odds of becoming disabled are much greater than dying during your work years.
  • There are several different types of disability coverage that are available. Besides individual and group disability policies, an important coverage is business overhead expense. This type of policy covers expenses such as salaries, rent, telephone, utilities, etc., to keep your office open. Disability buyout provides income to fund a buy-sell agreement triggered by the disability of a shareholder-employee.
  • As there are different types of coverage, there also are many features that vary from one policy to another. It takes a careful review of your personal needs in order to design a policy to take care of your disability needs.
  • Let’s take a few minutes to discuss the income tax consequences for disability income insurance policies. Generally, for personally owned policies, premiums are not deductible, but benefits are not includable in income.
  • Disability income policies where the business pays the premiums are taxed differently. In this type of setting, premiums are paid by the employer while benefits are payable to the employee. The employer is permitted to deduct the premium cost, premiums are not taxable to the employee and the benefits, when paid, are includable in the employee’s gross income.
  • As you could imagine, the disability of a business owner – you or your partner – can be devastating. To plan for the possibility of disability, many business owners adopt buy-sell agreements or amend existing agreements, to protect themselves and their businesses. There are special disability insurance policies that pay a lump sum after a business owner has been disabled for a specified number of months. The tax consequences of this type of policy are as follows: premiums are not deductible, but proceeds are not treated as taxable income to the recipient.
  • Most of you are familiar with the basics of qualified plans. There are rules set up that permit employers, both large and small, to provide employee benefits on a tax-favorable basis. Since a company’s contribution to its qualified plan is tax deductible and not includable in the income of the plan’s participants (until distribution at a later date), it makes sense for business owners to use profits not needed for current compensation by contributing them to a qualified plan for payment at a later date. It is possible and highly desirable to design a qualified plan that has eligibility, vesting and benefits that favor the business owner as opposed to the rank-and-file employees.
  • In addition to tax-deductible employer contributions, there are several features common to all qualified plans. Each type of qualified plan has its own maximum contribution amounts, while vesting schedules are common to all qualified plans. There is a myriad of possibilities for distributions under qualified plans. Typically, plan distributions should not start before age 59½ and should have started by age 70. The downside to tax-deductible contributions is that the federal government imposes heavy reporting and disclosure requirements on all qualified plans.
  • We’ll take just a few minutes to go over the different types of qualified plans. Perhaps the most traditional plan, typically referred to as a pension plan, is a defined benefit plan. In this arrangement, an employee with a retirement benefit based on salary and length of service. The employer’s cost is actuarially determined to be adequate to provide future benefits.
  • On the other hand, defined contributions plans focus on the amount of money contributed currently, not the amount to be available down the road at retirement. There are three types of defined contribution plans that you should consider. First is a money purchase plan, which has a definite formula for making contributions on behalf of employees each and every year. The second type of plan is a profit-sharing plan. Here an employer is allowed to make discretionary contributions on behalf of employees. The amount of contribution may be based on the company’s profits in a given year, but there is no requirement that this be the case. The third type of defined contribution plan of interest is a 401(k) plan. Named after the tax-code section that describes it, a 401 (k) plan contains all the provisions of a profit-sharing plan with an added feature. The added feature permits employee salary deferrals and matching contributions by the employer.
  • There are other qualified plans which exist on a somewhat smaller scale. No doubt everyone is familiar with IRAs. Individual retirement annuities (or accounts) are an excellent way for employees to build savings for retirement. Unfortunately, deductibility is dependent on income levels and participation in employer-sponsored retirement plans. A simplified employee pension plan (SEP) is an outgrowth of an individual IRA. With a SEP plan, the employer makes contributions to IRAs established for each eligible employee. A special type of qualified plan exists for tax-exempt employers. Called several different names, a tax-deferred annuity is sometimes called a tax-sheltered annuity (TSA) or referred to by its tax code section – a 403(b) plan. Whatever you call it, this type of qualified plan permits employees of certain tax-exempt employers to defer a portion of income by salary deferral in order to provide retirement benefits.
  • In a relatively short time, we’ve managed to review qualified retirement plan benefits. Now we will explore other types of qualified benefits that most of you are quite familiar with: group term life insurance and group health insurance. First, we’ll look at group term life insurance. Yes, premiums are deductible! Also, employees are not taxed on the employer-paid premiums unless the amount of coverage exceeds $50,000. If the face amount exceeds $50,000, the employer must compute the “cost” of the additional protection and notify the employee of the amount to include in his or her taxable income.
  • With this in mind, you need to adopt a personal estate plan in order to assure that your objectives will be met. You first need to establish lifetime objectives so that you can adopt a plan for distribution of your assets (including your business) at death. Not only should you be concerned with making sure your wealth reaches those people you select and in the manner you choose, but that your assets are not absorbed by estate taxes and settlement expenses. A good estate plan minimizes the effect of federal and state taxes while it ensures that these and other estate settlement costs can be paid without jeopardizing your family’s inheritance.
  • Over the next threeyears, under current laws, the estate tax goes through three distinct phases (shown above). There are a few key points to remember: First, the estate tax is alive and well. As you can see, the estate tax is scheduled to disappear for only one year, in 2010. The tax then reappears in 2011 under the laws in effect in 2001. To make matters more confusing, for the one year of estate tax repeal in 2010, the estate tax is replaced with a capital gains tax. There are some limited exemptions from the capital gain tax, but the message is clear - estate planning is as important as ever.
  • Under current laws, the estate tax exemption amount is $3.5 million per estate this year. The estate tax is repealed for one year in 2010. In 2011, the estate tax is resurrected with a much lower $1 million exemption amount. Of course, these amounts are subject to change by the government: therefore, maximum flexibility is key to sound estate planning.
  • The story is much the same for top estate tax rates with a 45% top rate in 2009. Please note, however, that the top estate tax rate (45%) is significantly higher than the top income tax rate (35%). The return of the estate tax in 2011 is especially painful with a top rate of 55%!
  • Focusing on 2009, depending on the size of the estate, the IRS stands to collect a hefty sum. The estate tax is a progressive tax. The wealthier you are, the more the tax collector takes. What the IRS gets, your heirs lose.
  • Without going into too much detail at this point, what are some of the estate planning issues that will specifically affect you as a business owner? At your death, the IRS will demand a percentage of your estate. While your business has a substantial net worth, it is highly illiquid. Where are you going to get the dollars to pay the estate taxes and expenses? Some popular estate planning techniques (i.e., the unlimited marital deduction) merely postpone the estate tax problem until the second death of a husband and wife, but the problem still exists. A second problem is the issue of business continuation. Your heirs will have to decide whether to sell the business or to continue operating it, absent any prior planning. Also, adjusting the interest of heirs who are active in the business with the interest of those heirs who do not participate in the business may be a major problem.
  • How do you divide up your estate – equally or equitably?
  • Partial solutions to the need to plan an estate exist. You can minimize taxes through effective estate planning and/or sell off part of the business to pay taxes. These are merely partial solutions. They do nothing to provide a cost-effective method or source of money to pay the IRS.
  • The good new is that there are complete solutions available. A funded buy-sell agreement, as we discussed earlier, can be an ideal method of providing your estate with the much-needed liquidity while at the same time assuring that the business will remain intact. An irrevocable life insurance trust is another solution to the estate planning problems of a business owner. Because our time here today is limited, I’ll only mention the irrevocable life insurance trust and say it can be the most effective estate planning tool available today. I’ll be happy to discuss it in detail with you at a later date if you would like to do so.
  • What do you have to lose?
  • As we have discussed, business insurance and fringe benefit planning involves a variety of strategies and solutions. What works best for one business owner may not fit every case. Tax and non-tax considerations must be weighed to determine what works best for a particular business owner. Every case is unique and requires careful analysis of all relevant facts.
  • I am here to help you tie your entire plan together bringing all aspects of your business insurance and retirement plan into focus. I would be glad to analyze your current situation to see how my services can help you enhance your current plan. If you do not have a business insurance plan in place, I would be glad to help you design one to meet your wants and needs.
  • Business Owner Insurance Planning By Mark Simon

    1. 1. Planning For Business Owners Presented by: Mark L. Simon Financial Services Professional California Insurance License No. 0E41454
    2. 2. Benefits For: <ul><li>You and your key persons only </li></ul><ul><li>All of your employees </li></ul>
    3. 3. Benefits For You & Your Key People: <ul><li>Supplemental executive retirement plan (SERP) </li></ul><ul><li>Executive bonus plan </li></ul><ul><li>Split-dollar insurance </li></ul><ul><li>Buy-sell funding </li></ul><ul><li>Key person protection </li></ul><ul><li>Disability income insurance </li></ul><ul><li>Estate planning </li></ul>
    4. 4. Benefits For All Employees: <ul><li>Qualified pension plans </li></ul><ul><li>Group life and health insurance </li></ul>
    5. 5. Ideal Fringe Benefit From a Tax Standpoint <ul><li>Current tax deductions for the business </li></ul><ul><li>Deferred tax to recipient </li></ul>
    6. 6. Cost to Corporation Corporate Tax Bracket (%) Tax-deductible Corp. Dollar After-tax Cost 34% $1.00 $.66 15% $1.00 $.85
    7. 7. Tax-Deductibility is only one factor to be considered
    8. 8. Ideal Fringe Benefit From a Planning Standpoint Relieves an employee of a personal non-deductible expense
    9. 9. Income Tax Rates <ul><li>Affect business planning </li></ul>
    10. 10. Personal Tax Bracket vs. Corporate Tax Bracket
    11. 11. Benefit Planning Key Questions: <ul><li>1. Is it deductible? </li></ul><ul><li>2. Who controls benefit values? </li></ul>
    12. 12. What is Most Important to You? <ul><li>Tax-deductibility </li></ul><ul><li>or </li></ul><ul><li>Control of benefit </li></ul>
    13. 13. Types of Business <ul><li>Sole proprietorship </li></ul><ul><li>Partnership </li></ul><ul><li>C corporation </li></ul><ul><li>S corporation </li></ul><ul><li>Professional corporation </li></ul><ul><li>Limited liability company (LLC) </li></ul>
    14. 14. Sole Proprietorship <ul><li>A business owned entirely by one person </li></ul>
    15. 15. Partnership <ul><li>An association of two or more persons as co-owners of a business for profit </li></ul>
    16. 16. Corporation <ul><li>A separate legal entity apart from its owners </li></ul>
    17. 17. S Corporations Enjoy: <ul><li>Limited liability </li></ul><ul><li>Employee benefit advantages (for non-shareholders) </li></ul>
    18. 18. S Corporation <ul><li>Taxed like a partnership </li></ul>
    19. 19. Professional Corporations <ul><li>Organizations of physicians, lawyers and other professional people </li></ul><ul><li>Treated as a corporation for tax purposes </li></ul><ul><li>Not taxed the same as C corporations </li></ul><ul><li>Can elect S corporation status </li></ul>
    20. 20. Limited Liability Companies <ul><li>An LLC member’s potential liability is limited </li></ul><ul><li>LLCs are not burdened by ownership restrictions applicable to S corporations </li></ul><ul><li>LLCs may have more than one class of stock </li></ul><ul><li>Preferred allocations of profits and losses are allowed </li></ul>*LLC law is relatively new and uncertain. Consultation with an LLC expert in your state is recommended.
    21. 21. Choosing the Form of Business Organization <ul><li>Taxation </li></ul><ul><li>Limited liability </li></ul><ul><li>Employee benefits </li></ul>
    22. 22. Key Person Insurance
    23. 23. Who is a Key Person? <ul><li>High salary level </li></ul><ul><li>Decision-making power </li></ul><ul><li>Ability to implement plans </li></ul><ul><li>Financial leverage </li></ul><ul><li>Special talent </li></ul>
    24. 24. Problems <ul><li>Disruption of management </li></ul><ul><li>Reduction in earnings </li></ul><ul><li>Impairment of credit </li></ul><ul><li>Loss of confidence </li></ul><ul><li>Replacement costs </li></ul>
    25. 25. How Key Person Insurance Works Key Employee Business Premiums Death Benefits <ul><li>Business owns and controls the policy. </li></ul><ul><li>Business is the premium payor and policy beneficiary. </li></ul><ul><li>Business receives tax-free death benefits. </li></ul>
    26. 26. Adopt A Corporate Resolution <ul><li>Why? </li></ul><ul><ul><li>To fully protect your business </li></ul></ul>
    27. 27. Executive Fringe Benefits
    28. 28. <ul><li>Supplemental Executive Retirement Plan </li></ul><ul><li>Split-Dollar </li></ul><ul><li>Custodial Executive Bonus </li></ul><ul><li>Executive Bonus </li></ul>Is Control Important? + EMPLOYER CONTROL -
    29. 29. Supplemental Executive Retirement Plan (SERP) Golden Handcuffs
    30. 30. SERP Defined <ul><li>“ A contract between an employer </li></ul><ul><li>and an employee to provide </li></ul><ul><li>retirement and perhaps death and/ </li></ul><ul><li>or disability benefits to select employees” </li></ul>Life insurance is purchased on the employee’s life to assist employer in meeting future obligations
    31. 31. SERPs Help Complete the Retirement Picture
    32. 32. How it Works Policy Benefits Premiums Agreement Retirement and/or Disability $ Business Executive Death Benefits Beneficiary Step1 Step 2 Step 3 Step 4 Step 5 Ins Co.
    33. 33. Advantages <ul><li>Places “golden handcuffs” on key employees </li></ul><ul><li>Attracts the best of the best and gives key employees an incentive to stay </li></ul><ul><li>Flexible benefits </li></ul><ul><li>Pick and choose participants </li></ul><ul><li>Corporation can recover its costs </li></ul><ul><li>Minimal compliance issues </li></ul>
    34. 34. SERPs and Taxes
    35. 35. Accounting for SERPs <ul><li>Funding vehicle carried as asset on corporate books </li></ul><ul><li>Promise to pay benefits is a corporate liability </li></ul>
    36. 36. Split-Dollar Insurance
    37. 37. Split-Dollar Insurance <ul><li>Ownership </li></ul><ul><li>Benefits </li></ul><ul><li>Premium </li></ul>An insurance policy is “split” between the business and the individual
    38. 38. Split-Dollar Applications <ul><li>Fringe benefit </li></ul><ul><li>Estate liquidity </li></ul><ul><li>Buy-sell planning </li></ul><ul><li>Group term replacement </li></ul>
    39. 39. Split-Dollar <ul><li>… a versatile fringe benefit that permits the acquisition of needed life insurance at a reduced cost </li></ul>
    40. 40. Premium Split Employer Employee
    41. 41. Death Benefit Split Employee’s Beneficiary Employer Split-dollar is also used to share policy cash value between an employer and an employee
    42. 42. Choices! Economic Benefit Plan Loan Plan Policy Owner Employer Employee Employee’s Cost Annual term value of death benefit Annual imputed interest income Policy Cash Values Employer owns entire cash value Employee owns cash value exceeding employer’s premiums Employer’s Share of Death Benefit Greater of total premiums paid or policy cash value Total premiums paid Employee’s Share of Death Benefit Balance of death benefit Balance of death benefit Cost Recovery When plan ends When plan ends
    43. 43. Rollout at Retirement <ul><li>Employer receives its premium payments back </li></ul><ul><li>Employee receives policy (minus employer’s premium) </li></ul>
    44. 44. Tax Consequences <ul><li>Employer: </li></ul><ul><ul><li>No deduction, but owns the cash value </li></ul></ul><ul><li>Employee: </li></ul><ul><ul><li>Taxed on economic benefit and any cash values received </li></ul></ul>
    45. 45. Retirement Planning <ul><li>What have you done? </li></ul><ul><li>Could you do more? </li></ul>
    46. 46. Would you be interested in tax-advantaged retirement cash flow?
    47. 47. Would you be interested in a plan where values grow tax-deferred?
    48. 48. Would you be interested in a plan that allows you to exclude all of your employees?
    49. 49. Would you be interested in a plan with minimal government rules or regulations?
    50. 50. Your Plan Utilizing the advantages of permanent life insurance
    51. 51. Permanent Life Insurance <ul><li>Policy cash values grow tax deferred </li></ul><ul><li>As long as the policy remains in force, withdrawals up to basis and loans are tax free </li></ul>
    52. 52. Take Care of YOUR Retirement Needs!
    53. 53. Executive Bonus Plan <ul><li>Compensates select key employees using life insurance </li></ul><ul><li>Simple to install </li></ul><ul><li>Costs of the plan are tax-deductible </li></ul>
    54. 54. How it Works Business pays premium Business receives current tax deduction Insurance policy is purchased Business Executive Income tax free Death benefit Heirs Ins Co. Premium is taxable bonus Executive owns policy <ul><li>Executive is taxed on bonus </li></ul><ul><li>Cash values build tax-deferred (as long as policy stays in force) </li></ul><ul><li>Policy cash values available for retirement or college funding </li></ul><ul><li>Cash values may be creditor protected (varies by state) </li></ul><ul><li>Death benefits may be used for estate settlement </li></ul>
    55. 55. Executive Bonus Plan  Under current tax law
    56. 56. How Custodial Executive Bonus Works Business pays premium Business receives tax deduction Insurance policy is purchased Business Executive Income tax free death benefit Heirs Ins Co. Premium is taxable bonus <ul><li>Cash values build tax-deferred ( as long as policy stays in force) </li></ul><ul><li>Accumulated cash value for retirement or college funding , subject to employer’s consent </li></ul><ul><li>Cash values may be creditor protected (varies by state) </li></ul><ul><li>Employer has “veto” power over executive’s access to policy cash values </li></ul>Employer restricts executive’s ability to exercise ownership rights Executive owns policy
    57. 57. Buy-Sell Planning
    58. 58. Triggering Events <ul><li>Death </li></ul><ul><li>Disability </li></ul><ul><li>Retirement </li></ul>
    59. 59. Every Business Has Three Values <ul><li>1. Going concern value </li></ul><ul><li>2. Liquidation value </li></ul><ul><li>3. Gone value </li></ul>
    60. 60. Advantages <ul><li>Guarantees a buyer </li></ul><ul><li>Establishes estate tax value at death </li></ul><ul><li>Provides for funding </li></ul><ul><li>Allows a smooth transition </li></ul>
    61. 61. You Want: <ul><li>Top dollar for your business </li></ul><ul><li>Prompt settlement </li></ul><ul><li>Fixed estate tax value at death </li></ul><ul><li>Relief to family from business worries </li></ul>
    62. 62. The Remaining Owners Want <ul><li>Full control of business </li></ul><ul><li>Minimum payment for business </li></ul><ul><li>No interference from deceased’s family members </li></ul><ul><li>Smooth & prompt transfer </li></ul><ul><li>Continuing line of business credit </li></ul>
    63. 63. Don’t ignore the issues… <ul><li>or you’re sure to have a problem! </li></ul>
    64. 64. Adopt A Buy-Sell Agreement And Fund It
    65. 65. Funding Methods <ul><li>Personal funds of buyer </li></ul><ul><li>Sinking fund </li></ul><ul><li>Borrowed funds </li></ul><ul><li>Installment payments </li></ul><ul><li>Life insurance </li></ul>
    66. 66. Advantages of Using Life Insurance <ul><li>Certainty </li></ul><ul><li>Income-tax-free proceeds at death </li></ul><ul><li>Cash value available </li></ul><ul><li>Cost efficient dollars </li></ul><ul><li>Strengthens credit </li></ul>
    67. 67. Two Types of Buy-Sells <ul><li>1. Cross purchase </li></ul><ul><li>2. Stock redemption </li></ul>
    68. 68. Cross-Purchase Plan 50 shares $250,000 A 50 shares $250,000 B Life Insurance Company B’s estate A 50 shares $250,000 Premiums Premiums Death proceeds $250,000
    69. 69. Stock Redemption B A 100 shares $200,000 C ABC Corp. 300 shares outstanding Valuation:$600,000 Life Insurance Company premiums death proceeds A’s stock is retired by corporation $200,000 death proceeds 100 shares $200,000 100 shares $200,000
    70. 70. Business Valuation Fair Market Value
    71. 71. Plan now for the successful future of your business
    72. 72. Disability Income Insurance
    73. 73. Your Most Valuable Asset <ul><li>Your ability to earn an income </li></ul>
    74. 74. Disability Coverage Types <ul><li>Individual </li></ul><ul><li>Group </li></ul><ul><li>Business overhead expense </li></ul><ul><li>Disability buyout </li></ul>
    75. 75. Typical Features <ul><li>Definition of disability </li></ul><ul><li>Partial or residual disability </li></ul><ul><li>Cost of living adjustment </li></ul><ul><li>Non-cancelable </li></ul><ul><li>Guaranteed renewable </li></ul><ul><li>Waiting or elimination period </li></ul><ul><li>Benefit periods </li></ul>
    76. 76. Taxation of Personally-Owned Disability Income Insurance Policies <ul><li>Premiums are not deductible </li></ul><ul><li>Benefits are income tax-free </li></ul>
    77. 77. Employer-Paid Policies <ul><li>Employer deducts premium </li></ul><ul><li>Premiums are not taxable to employee </li></ul><ul><li>Benefits are included in employee’s income </li></ul>
    78. 78. Disability Buy-Out <ul><li>Premiums not deductible </li></ul><ul><li>Proceeds not treated as taxable income </li></ul>
    79. 79. Qualified Plans
    80. 80. Features <ul><li>Tax-deductible employer contributions </li></ul><ul><li>Maximum contribution amounts </li></ul><ul><li>Vesting schedules </li></ul><ul><li>Distributions </li></ul><ul><li>Reporting & disclosure </li></ul>
    81. 81. Defined Benefit Pension Plans Retirement benefit is based on salary & length of service.
    82. 82. Defined Contribution Plans <ul><li>Money purchase </li></ul><ul><li>Profit sharing </li></ul><ul><li>401(k) </li></ul>
    83. 83. Other Qualified Plans <ul><li>412(i) Pension Plan </li></ul><ul><li>Traditional IRA </li></ul><ul><li>Roth IRA </li></ul><ul><li>SIMPLE IRA </li></ul><ul><li>Simplified Employee Pension (SEP) </li></ul><ul><li>Tax-sheltered Annuity (TSA) </li></ul>
    84. 84. Group Term Life Insurance <ul><li>Corporation deducts premiums </li></ul><ul><li>Employees not taxed on the premiums unless coverage exceeds $50,000 </li></ul>
    85. 85. A Personal Estate Plan: <ul><li>Plan of Disposition </li></ul><ul><li>Plan of Liquidation </li></ul>
    86. 86. The Estate Tax Roller Coaster <ul><li>Phase One (2009) </li></ul><ul><ul><li>Exemption amounts gradually increase </li></ul></ul><ul><ul><li>Top tax rate gradually declines to 45% </li></ul></ul><ul><li>Phase Two (2010) </li></ul><ul><ul><li>Estate tax repealed (for one year only) </li></ul></ul><ul><li>Phase Three (2011+) </li></ul><ul><ul><li>Estate tax returns with $1 million exemption and 55% top rate </li></ul></ul>
    87. 87. Estate Tax Exemption Amounts
    88. 88. Top Estate Tax Rates
    89. 89. The Estate Tax Bite in 2009 *Combined federal and state taxes. Assumes a state death tax with a $1 million exemption.
    90. 90. Problems You’ll Encounter as a Business Owner <ul><li>Estate taxes & expenses </li></ul><ul><li>Business continuity </li></ul><ul><li>Balancing interest of heirs </li></ul>
    91. 91. Distribution to Heirs Equally or Equitably
    92. 92. Partial Solutions <ul><li>Minimize taxes through estate planning </li></ul><ul><li>Sell off part of business to pay taxes </li></ul>
    93. 93. Complete Solutions: <ul><li>Funded buy-sell plan </li></ul><ul><li>Irrevocable life insurance trust </li></ul>
    94. 94. What do you have to lose? Except all your hard work and your business
    95. 95. Review: Planning Strategies
    96. 96. Review: Planning Services