Business Succession/Estate Planning – Tax, Non-Tax and Entity Considerations* - PowerPoint Presentation

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Business Succession/Estate Planning – Tax, Non-Tax and Entity Considerations* - PPT Presentation

Roger A McEowen Presented at the 2013 National Farm Business Management Conference Overland Park Kansas June 10 2013 Director of the ISU Center for Agricultural Law and Taxation Member of the Iowa and Kansas Bar Associations and licensed to practice in Nebraska ID: 636608

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Slide1

Business Succession/Estate Planning – Tax, Non-Tax and Entity Considerations*

Roger A.

McEowen

_______________

*Presented at the 2013 National Farm Business Management Conference, Overland Park, Kansas, June 10, 2013.

**Director of the ISU Center for Agricultural Law and Taxation. Member of the Iowa and Kansas Bar Associations and licensed to practice in Nebraska.Slide2

H.R. 8 - The Fiscal Cliff Bill

What the Bill does not do:

No extension of the payroll tax cut

6.2% rather than 4.2% ($113,700 wage base)

Applies to wages paid and self-employment income paid with return

Note:

Don’t forget .9% Medicare surtax on earned income exceeding $250,000 (MFJ); ($200,000 single)

Does not address carried interestSlide3

HR 8: the Fiscal Cliff Bill

Ordinary Income Rates

Old Law:

Top rate of 35%, starting at taxable income MFJ, $388,350

New Law:

Top rate of 39.6%, starting at $450,000 MFJ taxable income, $400,000 single. Slide4

HR 8: the Fiscal Cliff Bill

New Brackets

Single

To $8925

-to $36,250 15%

-to $87,850 25%

-to $183,250 28%

-to $398,350 33%

-to $400,000 35%>$400,000 39.6%

MFJ

To $17,850

-to $72,500 15%

-to $146,400 25%

-to $223,050 28%

-to $398,350 33%

-to $450,000 35%

>$450,000

39.6

% Slide5

Marriage Penalty Returns (and is worse than before)

Example

Married couple with each earning wages of $400,000

Income tax owed - $260,000

Medicare surtax - $4,950

Two single persons living together each earning wages of $400,000

Income tax owed - $228,000 (total)Medicare surtax - $3,600 (total)Slide6

HR 8: the Fiscal Cliff Bill

New Brackets

39.6% bracket for trusts begins at $

11,950 for 2013(replaces

old 35% bracket

)

Note: This is the IRS position, but it may not be correct – rate may only be 35%Slide7

Trust Tax Rates

Sec. 101(b)(1)(B) of ATRA adds I.R.C. Sec. 1(

)(3), which says that rate of tax under subsections (a),(b), (c) and (d) rises from 35% to 39.6% for income above the “applicable threshold”

Trusts and estates are not taxed under any of these subsections

ATRA provides no threshold amounts at which the 39.6% bracket would start

Thus, 39.6% bracket should not apply to trusts and estatesSlide8

HR 8: the Fiscal Cliff Bill

Phase-out of itemized deductions

(The “Stealth Tax”)

Itemized deductions phase out for each dollar of AGI over:

$300,000 (MFJ) $275,000 (HOH)

$250,000 (Single filers

)$150,000 (MFS)So, what’s the impact of reinstating PEP and PEASE?PEP reduces personal exemption by 2% for every $2,500 of income above the threshold amount for single taxpayers and every $1,250 of income above threshold amount for MFJPersonal exemption is $3,800/person, so a married couple with 2 kids with incomes above $300,000 (up to about $425,000) will have about a 4% increase in marginal tax rateSlide9

Pease Limitation

Pease cuts itemized deductions by 3% of AGI above the threshold amounts up to maximum of 80%

Deductions not included:

Investment interest

Medical expenses

Casualty, theft and wagering lossesSlide10

HR 8: the Fiscal Cliff Bill

Phase-out of itemized deductions

(The “Stealth Tax”)

The phase-outs cause tax increases to kick in at much lower levels.

-Families in 33% bracket could have an effective marginal rate exceeding 38%

-Families in 39.6% bracket would have an effective rate over 46% (after adding in Medicare surtax of 3.8%)

Slide11

HR 8: the Fiscal Cliff Bill

New Brackets, adjusted for phase outs

Single

$183,250-$398,350 (33.99%)

$398,350-$400,000 (36.05%)

$400,000 and up (40.788%)

MFJ

$223,050-$398,350 (33.99%)

$398,350-$450,000 (36.05%)

$450,000 and up (40.788%) Slide12

HR 8: the Fiscal Cliff Bill

New Capital Gain Brackets

(as applied to taxable income)

Single

To $8925

-to $36,250 0%

-to $400,000 15%

>$400,000

20%

MFJ

To $

17,850

-to $72,500 0%

-to $223,050 15%

-to $398,350 15%

-to $450,000 15%

>$450,000

Adjust for the phase-outs as needed.Slide13

How Do The Higher Rates Apply To Clients With Both Ordinary Income and LTCGs?

Example:

Bob and Mary file as MFJ and have ordinary income of $300,000 and LTCG of $200,000. Thus, taxable income after deductions is $500,000

Threshold for 39.6% rate is $450,000, so at what rate is the capital gain taxed? In other words, what is the ordering rule?

Does the capital gain get applied to the threshold first, so that it’s taxed at 15%?

Does the ordinary income get applied to the threshold first, so that none of the ordinary income is subject to the 39.6% rate, and a portion of the capital gain is taxed at 15% and the balance at 20%?Slide14

Capital Gain/Ordinary Income Ordering Rule

Of course, the Congress didn’t answer the question in H.R. 8

Look to I.R.C. §1(h)

Determine portion of taxable income that will be subject to ordinary rates using graduated rate tables

Greater of taxable income reduced by capital gain ($300,000), or

Lesser of

Amount of income taxed at rates below 25% ($72,500 for MFJ in 2013), orTaxable income less adjusted capital gain ($300,000)Slide15

Continuing the ExampleThe $300,000 of the $500,000 of taxable income is taxed at ordinary income rates, subject to the graduated rate tables

None taxed at 39.6% (even though taxpayer has taxable income over $450,000) because their ordinary income does not exceed $450,000Slide16

Continuing the Example

How much of the LTCG is subject to the 0% rate?

H.R. 8 extends the 0% rate for taxpayers otherwise in the 10% or 15% bracket.

The amount of the 0% rate is the lesser of:

Net capital gain ($200,000), and

The top of the 15% bracket ($72,500) reduced by taxable income less adjusted taxable gain ($500,000 - $200,000) [$72,500 - $300,000 = 0]

Thus, none of the capital gain is taxed at the 0% rate.Slide17

Capital Gain Example

Clay Tile

$600,000 of Schedule F net income for 2013.

Sale of farmland in 2013 that had

unharvested

crop

LTCG of $800,000$60,000 of itemized deductionsSlide18

Capital Gain Example

Tax issues associated with

unharvested

crop

No deductions for expenses (add to basis)

Gain is LTCG if land held for more than a year

Allocate portion of selling price to unharvested cropResult changes if retained right to reacquire landWhat about pre-paid expenses?Amended returnPotential application of 3.8 Medicare surtaxSlide19

Return to Clinton Era Tax Rates?

The Administration touts the deal as a “return to Clinton-era tax rates”

Not a chance:

Capital gain rates about 3-5% points higher

Medicare tax is higher

Stealth tax makes individual rates higher than advertised

Economic growth slowed down (as did revenues) after the Clinton tax hikeReal wages declined Slide20

HR 8: the Fiscal Cliff Bill

At least we have an AMT fix

-Single AMT exemption for 2012:

50,600

-MFJ AMT exemption for 2012: $78,750

-Adjusted henceforth for inflation

-Retroactive for tax years beginning after

2011

, an individual can offset their entire regular tax liability and AMT liability by the nonrefundable personal credits

-Adjust for the phaseouts as neededSlide21

HR 8: the Fiscal Cliff Bill

AMT Capital gain rates

They are same as regular tax capital gain rates, but using AMT taxable income.Slide22

HR 8: the Fiscal Cliff Bill

Permanency of Transfer Tax Provisions

Rate raised to 40% (from 35%)

Lifetime exemption remains at $5 million, with inflation indexing ($5,250,000 for 2013 deaths)

The exclusion remains coupled

Matching Gifting and GST exemption

“Portability” retained (surviving spouse can inherit decedent’s unused exemption)

2Slide23

Transfer Tax Changes

The rate change is easy to deal with

No carryover effect from year-to-year or from gifts to estates

No need to revise familiar estate planning techniques

New law doesn’t give any reason to alter existing plans

But revisit plans where there have been changes in finances or personal lifeSlide24

Transfer Tax Changes

How the new rate structure works:

40% rate reached at a taxable estate or cumulative gifts of $1 million

The “run up the brackets” for the first $1 million is $54,200 (i.e., any tax payable would be $54,200 less than if the tax were a flat 40% from the first dollar)

Unified credit is $2,045,800 and offsets a taxable estate (or taxable gift) of $5.25 millionSlide25

State Estate TaxesState estate taxes remain deductible in calculating the federal taxable estate

In those states (most of them) that don’t have an estate tax, or have a state estate tax that is coupled to the (now extinct) state death tax credit, 40% will be the only estate tax rate above the exemptionSlide26

State Estate Taxes

Most states that have an estate tax tie it to the pre-2002 federal credit for state death taxes

Top rate of 16% for taxable estates over $10.1 million

In states that follow the federal law and allow a deduction for the state tax, the total federal and state top marginal rates will be 48.3% Slide27

Portability

Made permanent

Technical correction made

“Basic exclusion amount” changed to “applicable exclusion amount” in I.R.C. §2010(c)(4)(B)(i)

June 15, 2012 portability regulations remain applicable

Still have to file Form 706 in first spouse’s estate to make election

9 months after death with 6 month extension possibleSlide28

Impact of Portability

Since it is now “permanent,” the use of bypass trusts for all but the wealthiest of families might be reduced

But, there are still reasons to use bypass trusts:

Protect assets from creditors

Surviving spouse might remarry

Assets might go down in value

Plan might already use a bypass trustBypass trusts avoid administrative pitfallsSlide29

Estate Planners Not Irrelevant

Many non-tax reasons to see an estate planner:

Asset protection through entities, trusts, pre-

nups

and post-

nups

Planning for long-term health carePowers of attorneyReviewing beneficiary designations and coordinating them with estate planBusiness successionSlide30

GSTTMade permanent is the allocation of the GSTT exemption and the GSTT inclusion ratio

Exemption same as that for estates and gifts ($5.25 million for 2013)Slide31

Transfer Tax IssuesWhat was not included in the bill:

No attack on valuation discounts

No 10-year term limit on GRATs

No limit on the duration of the allocation of the GSTT exemptionSlide32

HR 8: the Fiscal Cliff Bill

Retroactive business extenders

5-year S corporation built-in gain recognition period

For 2012 and 2013 (10 year rule in 2014)

Thus, S corporations with BIG that have been an S for at least 5 years as of the beginning of 2012 or 2013 will not owe BIG tax on sale of appreciated assets

If installment sale made after recognition period (e.g. 5 years) and recognition period reverts to 10 years, gain on installment sale is protected from BIG tax

If BIG income is carried forward to future years due to taxable income limitations and BIG period has expired, no BIG tax on expired amount

3Slide33

HR 8: the Fiscal Cliff Bill

Energy-Related Provisions

“Renewable” Energy PTC

Extended for one year

Taxpayer can make irrevocable election to take a 30% energy credit instead of the PTC

Qualified property defined as being constructed, reconstructed, erected or acquired by the taxpayer and the original use of which commences with the taxpayerSlide34

HR 8: the Fiscal Cliff Bill

Section 179 limit raised for 2013 – and

2012

Limit for 2012 had been $139,000, with deduction starting to phase out at $560,000.

2013 limit had been $25,000, with phase-out starting at $200,000

2Slide35

HR 8: the Fiscal Cliff Bill

Section 179 limit raised for 2013 – and

2012

New law boosts limit for both 2012 and 2013 to $500,000, with

phaseout

starting at $2 million.

Windfall for clients that purchased expensive assets in 2012 and thought they would be limited to $139,000

Limit to return to $25,000 in 2014.

The $139,000 amount for 2012 is gone

2Slide36

HR 8: the Fiscal Cliff Bill

Section 179 provisions from 2011 extended

Includes treatment of up to $250,000 in “qualified real property” expenses and qualification of computer software for Section 179 treatment.

You can still

make

or revoke a Section 179 election on an amended return for open tax year

Good through tax years beginning before 2014

Huge planning opportunitySlide37

Bonus Depreciation50% first-year bonus depreciation extended for 2013

3Slide38

Expense Method and Bonus Depreciation

Sec. 179

New or used equipment

No farm buildings, unless they are single-purpose agricultural/horticultural structures

Use in trade or business

Must have income from trade or businessSlide39

Expense Method and Bonus Depreciation

Bonus Depreciation

20-year MACRS property or less

Must be new

Farm buildings

Ordering rule

Sec. 179 first, then bonus, then regular MACRSSlide40

Charitable Donation To Charity From IRA

Reinstated for 2012 and extended through 2013

Must be over age 70.5

Limit is $100,000 annually

Donation must be to qualified charity directly (trustee of IRA must draft check in charity’s name)

Any distribution received during 12/12 not included in income if donated during 1/13

Distribution cannot be taken into account for determining the “other” charitable contributions to be allowed as a deduction under I.R.C. Sec. 170In other words, the distribution cannot be added to AGI for purposes of the AGI limitationCan help avoid 3.8% Medicare surtax (if desire is to benefit charity)Required distribution is passive and counts toward threshold, but not if donated directly to charitySlide41

ACA (Obamacare) Provisions Starting in 2013

Medical expenses (Schedule A)

Reduced by 10% of AGI for those under age 65

Applicable if either spouse under age 65

If 65 or older, reduced by 7.5%

Applicable if either spouse 65 or older

7Slide42

New Excise Tax on Medical Reimbursement Plans

I.R.C

. Sec. 4376.

amendment to ERISA added by

ACA. Imposes a "fee" on any applicable self-insured health plan for each plan year ending after 9/30/2012. Fee is $1 per average number of lives covered under the plan for plans that end during fiscal year 2013, $2 thereafter. The fee is to be paid by the "plan sponsor" defined as the employer for plans established or maintained by a single employer. An "applicable self-insured plan" is any plan for providing accident or health coverage if any portion of the coverage is provided other than through an insurance policy and is established or maintained by 1 or more employers for the benefit of their employees. An excise tax remitted via Form 720. First payment is due Jul. 31 for the calendar year 2012. Basically, it's due seven months after the plan year end. It doesn't apply to plan years ending after 9/30/2019.Slide43

Proposed regulations on 3.8% tax on “Net Investment Income”Slide44

The ACA imposes

two

related taxes

A 0.9% wage tax high-income individuals, paired with a 0.9% self-employment tax at the same income levels. (Sec. 3101(b)(2))

No employer match on the 0.9% tax

A 3.8% tax on "investment income" at higher AGI levels. (Sec. 1411)6-7Slide45

Wage/SE tax applies to:

Wage/SE income over $200,000 for single filers

Joint wage/SE income over $250,000 for joint filers, or

Wage/SE income over $125,000 for married taxpayers filing separately.Slide46

Wage/SE tax

Employers

will have to withhold when wages for an individual exceed $200,000. Any shortfall or overpayment has to be dealt with on the employee 1040.

Example:

Jack and Jill each earn $150,000 in 2013 wage income. Because both are below $200,000, no 0.9% tax will be withheld on their wages. When they file their

2013 return, they will owe $450 (($300,000-250,000) x .9%) as additional tax on their 1040.Slide47

Implications for partners?

Choose

your poison

you materially participate in a partnership with trade or business income, you will have self-employment income, potentially subject to the .9% tax – and the old 2.9% Medicare tax

.If not, you will have passive income subject to the 3.8% tax.Slide48

Implication for S corporations:

reason to keep a lid on "compensation."

corporation K-1 income is not subject to FICA or SE tax

.Reasonable compensation required.Slide49

Implication for Entity Planning

S corporation is favored over partnerships because of better ability to avoid both employment tax and investment income tax of active owners.Slide50

Investment income (Sec. 1411)

3.8% tax applies to lesser of “net investment income" or the excess (if any) of the taxpayer’s "modified AGI" over:

$200,000 for single filers

$250,000 for joint filers, and

$125,000 for married taxpayers filing separately.

Top bracket cutoff for trusts ($11,950 in 2013)Slide51

NII

The 3.8% surtax is not deductible

Self-employed persons can’t claim the surtax as part of the 50% deductible portion of S.E. taxes under I.R.C. §164(f).Slide52

Investment income includes:

Interest not derived in the ordinary course of a trade or business. (Preamble Sec. 5.A)

This excludes interest earned in a banking business. See Preamble Sec. 5.A.vi.

Dividends

Rents

Non-qualified annuities to extent

taxable and required minimum distributionsRoyaltiesCapital gains, except from sales of active businessesBut, include capital gain from sale or liquidation of closely-held C corporation, even though taxpayer materially participatedPassive trade or business incomeSlide53

“Net Investment Income” Does Not Include

Salary, wages or bonuses

Distributions from IRAs or qualified plans

Pension income

Any income taken into account for self-employment tax purposes

Gain on the sale of an active interest in a partnership or S corporation

Items which are otherwise excluded or exempt from income under the income tax lawSlide54

Capital

gain from the sale of interests in partnerships and S corporations (1.1411-7)

The partnership or S corporation is deemed to dispose of all of the entity's properties in a fully taxable transaction for cash equal to the fair market value of the entity's properties immediately before the disposition of the partnership or S corporation interest.

Determine the amount of gain or loss for each property.Slide55

Capital

gain from the sale of interests in partnerships and S corporations (1.1411-7)

3. “Applying the rules of chapter 1, the partnership or S corporation determines the amount of gain or loss for each property that is allocable to the interest disposed of by the transferor.”

4. Adjust out the gain attributable to non-passive property items from the total gain.Slide56

Sec. 1411 tax

Running investment income through a pass-through that otherwise has trade or business income does not avoid the tax. Slide57

Net Investment Income:

Itemized Deductions

Taken into account to extent allowed as a deduction. Examples include

Investment interest

Investment expenses (e.g., >2% AGI)

Income taxes “properly allocable” to gross income. Allocation based on gross income is proper (1.1411-4(f)(3)(C)Pass-through entity disclosure isn’t addressed. Query state taxes on pass-through income (e.g. Illinois, California, Kentucky) and composite state taxes.Slide58

3.8% Surtax – Application to Trusts and Estates

3.8% of lesser of undistributed NII for the tax year, or the excess (if any) of AGI for tax year, over the dollar amount at which highest tax bracket begins ($11,950 for 2013).

Note:

If beneficiaries do not have sufficiently high MAGI and passive income such that they would not be subject to the 3.8% surtax, and are not otherwise in the highest marginal tax bracket, fiduciary should distribute the amount of AGI for trust or estate that exceeds the threshold for the top rateSlide59

Trusts and Passive Income

The IRS view is that only the trustee, acting in its capacity as trustee, can satisfy the material participation test for a trust

No regulations

The one court that has decided the issue said the IRS position is “arbitrary, subverts common sense, and attempts to create ambiguity where there is none”

Tax Court case pending.Slide60

3.8% Surtax

Critical terms:

Net investment income

Threshold amount

$200,000 (single)

$250,000 (MFJ)

$11,950 (trusts and estates)Modified adjusted gross incomeAGI (line 37 of 1040) plus net foreign earned income exclusionSlide61

Illustration of investment income:

MAGI

Investment Income

Wages

300,000

Interest

10,00010,000Non-qualified Annuity20,00020,000403(b) annuity30,000Gain on stock sale40,00040,000Gain on principal residence

800,000

Residence

gain exclusion(500,000)(500,000)Total

700,000

370,000Slide62

Illustration of function of income

threshold:

MAGI

Investment Income

Wages

150,000

Dividends5,0005,000Interest15,00015,000403(b) annuity30,000Gain on stock sale

40,000

Passive Income

15,00015,000Non-passive income

5,000

Total

260,000

75,000

Tax

Base

10,000

75,000

Tax

380Slide63

Another Example

Single taxpayer

$100,000 of salary

$50,000 of net investment income

MAGI is $150,000

MAGI is less than threshold – no 3.8% taxSlide64

Another Example

Single taxpayer

$0 employment income

$225,000 net investment income

MAGI is $225,000

MAGI exceeds threshold by $25,000

Surtax is .038 x $25,000 = $950Slide65

Another Example

Married filing jointly

$300,000 combined salary

$0 net investment income

No surtax (wages exempt)Slide66

Another Example

MFJ

$400,000 salary income

$50,000 net investment income

Surtax applicable to $50,000 of net investment income

.038 x $50,000 = $1,900Slide67

Another Example

MFJ

$200,000 salary income

$150,000 net investment income

Excess of MAGI over threshold is $100,000

Surtax is .038 x $100,000 = $3,800Slide68

Another Example

Single

$200,000 investment income

$125,000 RMD from IRA

MAGI is $325,000

Excess of MAGI over threshold is $125,000

Surtax is .038 x. $125,000 = $4,750Slide69

Another Example

MFJ

$100,000 pension income

$150,000 IRA income

$25,000 tax-exempt interest

There is no net investment income, so no surtaxSlide70

Passive income tests

500 hours in an

activity

Significant participation - 100-to-500 hour activities that add to 500 hours in a

year

Substantially-all participation in the

activity100 hours, and as much as anyone elseMaterially-participated in 5 of last 10 years (or any three years for personal service businesses)Slide71

Special Rule F

or “Retired" Farmers

aterial participation in 5 years in the eight year period before you start drawing social security is evergreen.Slide72

Special

rule for real estate professionals

to avoid "per-se passive" treatment: threshold test

750 hours of participation in real estate trades or businesses owned, and

More real estate hours than anything else.Slide73

Recharacterization

Tax rules treat some otherwise passive income as non-passive, including

Land rent (under 30% of unadjusted basis depreciable)

“Self-rental” to a material participation activitySlide74

Grouping: real estate and other items.

What is an "activity?"

Sec. 469(c)(7) grouping election for real estate

pros

Other taxpayers can group appropriate units, but must disclose groupings and cannot change absent material change in circumstances.Slide75

Grouping basics (1.469-4(d))

Rental and trade or business activities may not be grouped unless one is “insubstantial” with respect to the other

Real property rental activity cannot normally be grouped with personal property rental

You can group activities of renting from one activity to another if both activities have identical ownership.Slide76

Disclosure of groupings (Rev. Proc. 2010-13)

Grouping changes must be disclosed on returns.

Once made, groupings can’t be changed by taxpayer unless initial grouping was “clearly inappropriate” or there was a “material change in circumstances”.

New activity groupings must be disclosed.Slide77

Special grouping election in proposed regulations (Proposed Reg. Sec. 1.469-11(b)(3)(iv)).

May regroup activities in first taxable year beginning after December 31, 2013 that they are over the income threshold and have net investment income

Taxpayers over the threshold may regroup for 2013

Taxpayers may only regroup once under this provision

.Regrouping must be disclosed pursuant to 1.469-4(e) and other regrouping rules.Slide78

Required disclosure (1.1411-7(d))

description of the disposed-of

interest;

The

name and taxpayer identification number of the entity disposed of;

The fair market value of each property of the entity; The entity's adjusted basis in each property; Slide79

Required disclosure (1.1411-7(d))

The

transferor's allocable share of gain or loss with respect to each property of the

entity

Information

on whether property was subject to the

taxThe net amount of gain, andThe computation of the gain subject to the Sec. 1411 tax. Slide80

Self-rental

Are "self-rentals" that are non-passive subject to the 3.8% tax as rentals?

“Self-rental” income that is not passive under the passive loss “recharacterization” rules will still be subject to the Sec. 1411 tax. Preamble Sec. 6.B(i)(b)(3)Slide81

Real estate professionals

Real

estate professionals get lame

guidance:

If a taxpayer meets the requirements to be a real estate professional in section 469(c)(7)(B), the taxpayer's interests in rental real estate are no longer subject to section 469(c)(2), and the rental real estate activities of the taxpayer will not be passive activities if the taxpayer materially participates in each of those activities. However, a taxpayer who qualifies as a real estate professional is not necessarily engaged in a trade or business (within the meaning of section 162) with respect to the rental real estate activities.Slide82

Planning issues

Affects gifting, grouping decisions

Compensation issues. If you are going to claim material participation in an S corporation or LLC, you should expect to pay wages or SE tax

Monitoring participation: if participation is even potentially iffy, the taxpayer should keep a current time diary.Slide83

Implications for Trusts

Trusts threshold is the top tax rate

bracket

under the proposed regulations (1411(a)(2

)).

Surtax applies to lesser of undistributed NII or the excess of an estate/trust’s AGI over $11,650

Regulations allocate investment income between distributed and undistributed income under usual trust allocation rules.Electing small business trusts will have to combine their S corporation and non-S corporation portions for computing the tax (Proposed § 1.1411-3(c)(1)(ii)).Slide84

3.8% Surtax – Planning Strategies

Anything that reduces NII or MAGI will reduce or eliminate the 3.8% surtax

Increase municipal bond investments

Maximize qualified plan contributions

Avoid spikes in income

Structure farm business as a member-managed LLC

While non-manager’s interest is passive, spouse can take into account m.p. of manager-spouseSlide85

SUCCESSION

PLANNING

Volume B, Chapter 5Slide86

Reasons Why Businesses Don’t Have Succession Plans

Successor doesn’t believe that the predecessor will ever retire

Arthur Andersen survey

Between 25% and 33% of leaders of family businesses don’t intend to retire or plan to remain involved throughout their lives

30-40% of family businesses have no plan in place

Taboo subject

Relationships and emotions involvedBusiness may be founder’s self-identificationAnimosity toward younger generationPrimogenitureSlide87

OBJECTIVES OF SUCCESSION PLANNING

Objectives must drive the process and must be clearly articulatedSlide88

Objectives of Succession Planning

Successfully bringing the next generation into the business

Providing vocation for next generation

Establishing a base for a financially successful business into future

Providing a plan for the older generation

Providing an estate plan that is fair to business and non-business heirs

Tax minimization

B197Slide89

Thread Through Other Efforts

Estate Planning

Business Planning

Succession PlanningSlide90

Steps to Successful Succession Planning

Determine business owner’s long-term goals and objectives

Determine financial needs of business owner and spouse and develop plan assuring financial security

Determine who will manage the business and develop the management plan

Determine who will own the business and how to transfer owner’s interest

Minimize transfer taxes and establish estate planSlide91

BUSINESS ORGANIZATION STRATEGIES

B198Slide92

Single Entity

Most U.S. Businesses

70 to 75% of farms and 50-60 percent of non-farm businessesSlide93

Multiple Entities

OPERATIONAL ENTITY

REAL ESTATE ENTITIES

Sole Proprietorship

Partnership

LLC

C CorporationS Corporation

__lease____

Parents’

capital

Child’s

capital

Equipment

LLC

B198Slide94

Operational Entity

Typical choices include:

Sole proprietorship

General partnership

LLC

C Corp

S CorpSlide95

Operational Entity

Assets Possible to Be Placed into Business

Checkbook

Inventory

Equipment

Very Limited Real EstateSlide96

Landholding Entities

Selected entity is usually sole proprietorship or LLC

Typically not wise to put real estate in corporationSlide97

Basic Entity Choices

(See Pages B199-200 for Summary Table)

Sole Proprietorship

General Partnership

Limited Partnership

Limited Liability Company

Limited Liability PartnershipS CorporationC CorporationCooperativesSlide98

Primary Considerations in Choosing Entity Form

Continuity

Corporation

Sole proprietorship

General partnership

Giles v. Giles Land Co. (Kan. Ct. App. 2012)Slide99

Removing a Partner Without Terminating the Partnership

Giles v. Giles Land Co. (Kan. Ct. App. Jun. 15, 2012)

State partnership dissociation statute invoked to remove the “magnanimous savior of the family”

Must value and buy-out his interest

Note:

In a limited partnership, a limited partner can assign their interest without impacting dissolution

B201Slide100

Transferability of Entity Interests

Transferring entity interests rather than individual assets

Partnership interests

LLC interests

Is transferred property subject to debt?

What about bankruptcy exemptions?

B201-202Slide101

Flexibility

Corporation – perhaps greatest in terms of management structure

Partnership – look to the agreement

LLC – the agreement controls

Based on state law, chance for greater creditor protection

Passive loss issueSlide102

LLCs and the Passive Loss Rules

How is a loss characterized?

Depends on whether the taxpayer is materially participating

Seven tests for material participation

Per-se rule of non-material participation for limited partner interests in a limited partnership

unless the Treasury specifies differently in Regulations

Statute pre-dates states LLC statutes and advent of LLPsThree tests for limited partners in a limited partnershipSlide103

LLCs and the Passive Loss Rules

I.R.C. §469(h)(2)

Per-se rule of non-material participation for limited partner interests in a limited partnership, unless regulations specify differently

“Except as provided in regulations, no interest in a limited partnership as a limited partner shall be treated as an interest with respect to which a taxpayer materially participates.”Slide104

Garnett v. Comr., 132

T.C. No. 19 (2009)

Taxpayer incurred losses in LLCs and IRS characterized them as passive under the “per-se” rule

Tax Court rejected IRS position

LLC is materially different than a partnership

Oregon Federal District Court had already ruled similarly based on Oregon lawSlide105

Thompson v. Comr

87 Fed. Cl. 728

(2009)

IRS position again rejected

IRS position given no deferenceSlide106

Hegarty

v. Comr.,

T.C. Sum. Op. No. 2009-153

Follows

Thompson

and

GarnettSlide107

Newell v. Comr., T.C. Memo. 2010-23

Is the managing member’s interest in a California LLC that was classified as a partnership for income tax purposes a limited partnership interest for purposes of Sec. 469?

IRS said it was

Court (again) said it was not

No unforeseeable circumstance presentSlide108

Rental Activities and the Passive Loss Rules

Remember, Sec. 469 disallows passive activity losses for any taxable year except to the extent they offset passive income

Rental activities are per se passive (with two exceptions)

Real estate professionals (Sec. 469(c)(7))

$25,000 annual deduction if AGI $150,000 or less (Sec. 469(i))Slide109

Rental Pros

Losses fully deductible if material participation present

But, what is a real estate pro?

More than 50% of personal services performed in trades or businesses by taxpayer during year must be performed in real property trades or businesses in which taxpayer materially participates

750-hours in real property trades or businesses in which taxpayer materially participatesSlide110

Chambers v. Comr., T.C. Sum. Op. 2012-91

Real estate professional test invoked

750 hours

More than 50% test

IRS said petitioner’s hours spent in LLC management activities didn’t count

Court disagreed based on

GarnettSlide111

Limited and General Partnerships

Prop. Treas. Reg. (Nov. 25, 2011)

For purposes of passive loss rules, focus is on whether taxpayer has right to participate in management at any time during tax yearSlide112

Organizational OptionsSelf-Employment Tax

If an LLC is not conducting a business, there is no self-employment income.

If an LLC is conducting a trade or business, then self-employment income results, unless the limited partnership exception exists (Sec. 1402(a)(13)).Slide113

Liability

Sole proprietorships and general partnerships

Unlimited liability

LLCs and corporations

Limited liability

Tax issues typically drive the decision

Charging orders (B203)Example 2B202Slide114

Liquidation Costs

C Corp

Highest liquidation cost

Distributions in excess of stock basis result in capital gain

S Corp

Others

LLCDistribution of assets on tax-free basisDiscounting of Business Interests

B204Slide115

Organizational Considerations

Income tax considerations

Double level tax for corporations other than S corporations

Recognition of gain on liquidation for S corporation liquidating distributions §311(b)

Flow-through tax considerations with no or limited gain recognition on liquidation for partnership-type entities

LLCs

LPsGPs, etc.B206Slide116

What To Consider Before Making S Election

Unused NOLs of C corporation cannot be used by S corporation to offset future S corporation income

S corporation compensation issues

Payment of “reasonable” wages

Payroll tax issue

Watson case

No cases involving issue of reasonable compensation where salary at least at FICA wage baseSlide117

Using an S Corp. To Minimize FICA & Medicare Tax

Watson, 668 F.3d 1008 (8th Cir. 2012)

Taxpayer earned 200,000 in 2002 and 2003 from CPA business but paid himself annual salary of 24,000 (firm established as a partnership of S corporations)

Court reclassified about $67,000 of S corp. dividends as salary for each year resulting in about $91,000 of FICA/Medicare wages

B206Slide118

S Corporation Tax Fails (Again)S. 2343

Would have applied payroll tax to taxpayers with income over $250,000 by requiring them to include for payroll tax purposes income received from an S corporation or L.P. interest in professional services business where 75 % or more of gross revenue derived from services of three or fewer shareholdersSlide119

S Corporation Disproportionate Distributions

Can make disproportionate distributions to correct disproportionate distributions

PLR 201236003 (Apr. 11, 2012)

B207Slide120

S Corp. Debt Basis Regs.How to increase basis:

Bona fide debt

Circular loans can work

Guarantees don’t work unless shareholder actually makes payment

Unsecured promissory note doesn’t workSlide121

Fringe Benefits

Health Insurance and retirement plans

Tax distinctions between various entities

Qualified retirement plan options

B207Slide122

Valuation Discounting

FLPs

No recognition of gain or loss for FIT purposes to either the party making the transfer or to the entity. Sec. 721(a)

Change in theoretical basis for fractional interest.

Interests in farmland if held by more than one person may qualify for fractional interest discounts.

Take the FMV of the land as a whole and subtract the estimated costs of a partition action divided by the percentage of land held

Once land is held by an entity, the valuation of units will be subject to normal lack of marketability, minority interest discounts and (perhaps) a control premiumB210Slide123

Valuation Discounting

FLPs

Change in status of property for state law purposes

Real estate of real property is normally sitused for purposes of state death tax statutes to the place where the land is located

Result not normally changed even if the land is held by a revocable trust

NOTE: LLC interests are generally personal property and personal property is generally sitused to the decedent’s state of residenceSlide124

Family Limited Partnerships

Keller, et al. v. United States, No. 10-41311, 2012 U.S. App. LEXIS 20119 (5th Cir. Sept. 25, 2012)

In 1998, $300 million transferred into revocable trust. FLP later created but not community property bonds that were to fund it not transferred before wife died on 5/15/00.

Estate paid over $147 million in estate tax in 2/01

FLP funded post-death

FLP funding meant that estate didn’t have funds to pay estate tax; transaction restructured as $114 million loan and estate issued promissory note at Feb. ‘01 AFR

Estate filed claim for refund in 11/01Slide125

Keller v. United States(5th Cir. Sept. 25, 2012)

Grounds for refund claim:

Failed to claim discount

Failed to claim deduction for interest paid on loan

Estate wins

Under TX law, the

intent to transfer the bonds to the FLP was sufficient – refund of $115 million Slide126

Current Developments in Estate and Business Planning

Family limited partnerships (FLPs)

Estate of

Wimmer

Making sure gifts of FLP interests qualify as present interests even where restrictions present

Right to income from the interests

FLP generated income from its investmentsSome portion of the income would flow to donees on consistent basisAmount flowing to donees could be ascertainedSlide127

You Can’t Take a 40% Discount on a 100% Interest

Estate of Lockett

Mrs. Lockett moved into an assisted living facility when her health began to decline and formed an FLP and funded it two years later with cash and marketable securities from her trust and her personal assets. Trust later dissolved, and Mrs. Lockett became sole owner of the partnership. Two sons listed as general partners in the agreement, but the sons never contributed any assets, and their interests were listed as 0 in the agreement.Slide128

Estate of Lockett

After the funding of the partnership, the partnership made loans to some of the children – many of which were documented in loan agreements with no terms on the principal payment, but with interest payments set up. The partnership also purchased some rental property and Mrs. Lockett kept some assets out of the partnership to care for herself.Slide129

Estate of LockettEstate filed a tax return and claimed 40% discount on the partnership assets

Two issues at trial,

Whether Mrs. Lockett held the assets individually or in the partnership; and

Whether the loans were gifts or loans.Slide130

Estate of Lockett

Court found no evidence of property contributed by the two sons or gifts of partnership interest to the two sons.

After the dissolution of the trust, Mrs. Lockett directly owned 100% of the partnership

FLP agreement supplemented that observation because it provided that if a partner acquired all the interests of the other partners, the partnership would dissolve.

Court ultimately found that the assets belonged to the estate, so no discounts were justified.Slide131

Estate of TurnerTransferred FLP assets were included in the decedent’s gross estate.

Court also addressed the issue of whether the decedent’s payment of life insurance policy premiums were subject to the annual exclusion under Section 2503(b).Slide132

Estate of Turner

Sloppy

Crummey

gifting

Decedent was grantor of irrevocable life insurance trust that had purchased three separate life insurance policies.

In 2000-2003, the decedent paid the insurance premiums directly from a joint checking account instead of transferring money to the trustees to pay the premiums.

IRS included the premiums paid on the life insurance policies in the estate’s total adjusted taxable gifts.Tax Court held that the premium payments were a gift of a present interest and were subject to the annual exclusion under Section 2503(b) – beneficiaries had “right to demand withdrawals from the trust”Slide133

Other FLP Issues

Estate of Stone

and

Estate of Kelly

Survive attack

Bona fides

Creation of family asset to be managed by familyTransferors not dependent on distributions from FLPNo commingling of personal and partnership fundsNo discounting of interests claimedTransferors in good health at time of transferNo evidence of implied agreementSlide134

HEIRS NOT IN THE BUSINESS

How to achieve equitable treatment

B213Slide135

Heirs not in the Business

Usually not wise to involve non-business heirs in day-to-day operations

Often do not distribute any income

Operational business may have day to day decisions that do not match objectives of business heirs

Ownership usually small compared to on business heirs

Little incentive for business heirs to buy out interest of non-business heir

Value of non-business heir’s minority interest has severe value discountSlide136

How to Treat

Non-Business Heirs

Inheritance or gift

Beneficiaries or life insurance

Beneficiaries of retirement plans

Acquire interest in business real estate

Possibly in conjunction with giftingSlide137

How to Treat

Non-Business Heirs

The non-business heir may not be distributed an equal share in the value of assets

If non-business heir were to receive real estate

Subject to long term rental contract in favor of business heir’s business

Subject to purchase options favoring business heir

Placed into an entity in which either all heirs are co-ownersSlide138

How to Treat

Non-Business Heirs

Seldom is it recommended that real estate be inherited by children as tenants in common

Joint decision making difficult

Each co-owner has power of partition

Usually no structured buy-out provision

Often questions of rights of possessionSlide139

Other Ways to Minimize Estate Tax?

“Charitable Lid” Planning

An estate plan is created where the testator leaves a set dollar amount of the estate to the children with the residuary estate passing to a charitable organization.

The portion passing to the charity qualifies for the estate tax charitable deduction and, thus, puts a lid on the amount of estate tax owed

B214Slide140

“Charitable Lid” Planning

Attractive technique when combined with hard to value assets such as business interests or family partnership interests

Good way to defeat an IRS audit

If IRS challenges the valuation of assets on audit, any increase in value on audit does not increase the estate tax due – it simply passes to the charity

B214Slide141

“Charitable Lid” Planning

Key case –

Christiansen v. Comr., 130 T.C. No. 1 (2008)

Decedent owned cattle ranches in South Dakota with her husband. He died in 1986 and she continued to operate the ranches until her death in 2001. Her entire estate passed to her daughter, but the will said she could disclaim all or any portion of her inheritance, with the disclaimed property passing 75 percent to a CLAT and 25 percent to a private foundationSlide142

Christiansen Case

Daughter filed a disclaimer. Largest asset in estate were FLP interests that carried out valuation discounts.

With discounts, decedent’s estate was just over $6.5 million

Daughter’s disclaimer resulted in the foundation and the CLAT receiving about $140,000

IRS audited and increased FLP interests by about 35% - but that resulted in more property passing to charity and no increase in estate tax

Daughter did not retain a continuing interest in the CLAT after the disclaimer, so no charitable deductionSlide143

Christiansen Case

IRS appealed the portion of the decision allowing the enhanced deduction for the amount passing to the foundation

Attacks the disclaimer:

Any amount passing to the charity was contingent on a condition subsequent (i.e., the Service’s ultimate determination of value of the decedent’s estate)

Adjustment clause in disclaimer should be declared void on public policy grounds – discourage them from examining estate tax returns

Court disagreed with IRS (586 F.3d 1061)Slide144

Petter v. Comr., T.C. Memo. 2009-290

Court upheld a defined-value gift tax clause and rejected IRS’ policy-based argument

UPS stock in LLC transferred to IDGTs and charities, with split determined by formula

IRS tried to negate defined-value clause based on policy reasons, but court determined that gift was of ascertainable value of stock rather than a specific number of shares or percentage interests in LLC

9th Circuit affirmed on appeal (Aug. 4, 2011)Slide145

Hendrix v. Comr., T.C. Memo. 2011-133

Court approved transfers with “defined value” formula provisions to limit gift tax exposure from the transfers

Transfer of closely held stock in a gift/sale transaction to family trusts and gift to Foundation under coordinated formula provisions was at arm’s length and not contrary to public policy

Clause at issue allocated stock between family trusts and Foundation based on values as determined by IRS willing buyer/willing seller test Slide146

Wandry

v. Comr., T.C. Memo. 2012-88

Facts:

arried

couple gifted membership units in LLC to children and grandchildren; transfers made in accordance with dollar value of gifts and were determined by a fraction (numerator was state dollar amount and denominator was value of entire company as determined by IRS or

court)IRS claimed gifts were of fixed fractional interests in LLC and, as a result, LLC unit value understated; court determined that defined value clause reallocated LLC membership units among parties in conformance with formula in which unit value as of transfer date was "unknown constant“IRS lostAppealable to 10th Cir. [Appeal docketed on Aug. 28]Case settled in late OctoberIRS issued non-acquiescence on Nov. 9, 2012Slide147

Life Estate/Remainder Arrangements

Handling Allocated Basis

Example:

At death, Sam leaves $500,000 of securities to his wife, Sara for life, with the remainder passing to his son, Sid. Sara is 48 at the time Sam dies. Under 20.2031-7A(c), the life estate factor for a female age 48 is .77488 and the remainder is .22512. Thus, the present value of the portion of the uniform basis assigned to Sara’s life interest is $387,440, with $112,560 assigned to Sid. Sara sells her life interest to her nephew, Seth, for $370,000 while she is still 48. Sara does not realize a loss (Sec. 1001(e)) and her gain is $370,000. Seth’s basis is $370,000 which is recoverable by amortization over Sara’s life expectancy

B225Slide148

Life Estate/Remainder Arrangements

Handling allocated basis

Example:

Same facts, except that Sara retains the life interest until age 60 and then sells it to Seth when the securities are worth $650,000. The life estate factor for Sara is .63226 and the remainder factor is .36774. So, the present value at the time of the sale assigned to Sara’s interest is $316,130 and the present value assigned to Sid’s interest is $183,870. Sara sells her interest for $410,969 ($650,000 x .63226). Her gain is the amount realized, and Seth’s basis is $410,969.Slide149

Life Estate/Remainder Arrangements

Handling allocated basis

Example:

Larry died at age 39 owning a pasture worth $18,800 at the time of death. The land is devised to Lance for life, remainder to Lisa (unrelated). Shortly after Larry’s death, Lance sells his life estate, Lance and Lisa jointly sell the entire property to Loraine for $25,000 and divide the proceeds equally. The remainder factor for a 39 year old male is .20146, thus the present value of the uniform basis assigned to Lisa’s remainder interest is $3,787.45. On sale, Lance realizes a loss of $2,512.55 ($15,212.55 - $12,500) [this is the portion of uniform basis not disregarded] and Lisa’s gain is $8,712.55 ($12,500 - $3,787.45). Loraine’s basis in the entire property is $25,000 (none recoverable by amortization deductions over Lance’s lifetime. Slide150

Dynasty TrustsThe GSTT

Tremendous planning opportunity through balance of 2012 to fund GSTT trusts

Watch for Administration’s continued attempts to limit planning opportunities

Limitation on GRATs

Elimination of valuation discounts via FLPs

B226Slide151

The GSTTClearly of interest to wealthy clients

Don’t overlook GSTT trusts for clients with more modest wealth

May not be of interest for small estatesSlide152

Dynasty TrustsAvoidance of transfer taxes for multiple generations

Lasts as long as allowed by maximum term allowed by local lawSlide153

Dynasty TrustsMechanics

Irrevocable trust

Spendthrift provision

Initial funding tied to grantor’s transfer tax exemption

Take note of the net investment return possible with enhanced exemption through 2012Slide154

Dynasty TrustsTax aspects

Not subject to GSTT if grantor allocates sufficient GSTT exemption to make inclusion ratio zero

Must elect to allocate exemption to transfers

Need to preserve GSTT inclusion ratio for any additional property transferred to the trust

B227Slide155

Dynasty TrustsTax aspects

Treated as an irrevocable trust

Initial funding subject to gift tax and will use up grantor’s unified credit to extent of excess over present interest annual exclusionSlide156

Dynasty Trusts

Can be structured as grantor trust

Income accumulated tax-free

During settlor’s lifetime, settlor taxed on trust income and gains

How to achieve grantor trust status:

Trust terms give discretion over distributions of income and principal that can be exercised by majority of trustees that are related or subordinate to settlor

B229Slide157

Trust TermTied to state’s rule against perpetuities

Establish situs in state with relaxed or no rule

Trust term should so state

Appoint trustee located in jurisdiction with favorable rule

Works for personal property

Real property governed by law of state where locatedSlide158

Dynasty TrustsTrustee considerations

Important to select carefully

Consider limitations on trustee’s exercise of power

What is the process for replacing a trustee

B230-231Slide159

Dynasty TrustsTrustee as a fiduciary?

Most courts require that trustee must commit serious breach before removal will be allowed

Statutory procedures may apply

UTC provision does not focus on trustee conduct

Trustee retained powers and tax issuesSlide160

Structure of the TrustCommonly drafted as spendthrift trust so as to provide asset protection

Beneficiary cannot assign or transfer or encumber an interest in net income or principal of trust

No creditor attachment until distribution

Trustee has absolute discretion over distributions

B230Slide161

The Use of Life Insurance as a Succession Planning Tool

General Comments

Tax favored status

What if estate tax (and stepped-up basis) is repealed

If in ILIT, death benefits not subject to FET or GSTT

B232Slide162

Life Insurance

Benefits of life insurance in business succession process

Estate liquidity and asset preservation

Ownership in ILIT

Proceeds payable to business owner’s estate via loans or buying assets from estate at FMV

ILIT could buy decedent’ s business interest at discount

Freeze accomplishedCash received by surviving spouse could be gifted to non-business heirs and/or fund ILIT for benefit of non-business heirsSlide163

Benefits of Life Insurance

Wealth replacement

Estate equalization

Fund a buy-sell

Tax hedge

Retirement income

Fund stock redemptionLiquidityNQDCSlide164

Benefits of Life Insurance

Key-person insurance

GRATs

Asset protection planning

Private annuities and SCINS

Family bankSlide165

GRATs and GRUTs

Types of irrevocable trusts

Established for a fixed term of years and the donor/grantor retains an income right

Stated amount paid to donor/grantor annually during term of trust

Upon termination, the trust fund is paid to the holders of the remainder

GRAT: income interest is a fixed sum of dollars determined at the outset of the trust, payable annually

GRUT: Grantor/holder receives amount equal to fixed percentage of FMV of trust. Percentage is fixed at time GRUT created. FMV of GRUT is determined annuallySlide166

Charitable Lead Annuity TrustsSimilar to a GRAT, but charity receives the annuity during the CLAT’s term of years

Remainder passes to donor’s family at a reduced gift tax value determined at outset of the trust

Donor receives charitable income tax and gift tax deduction for the annuitySlide167

Qualified Personal Residence Trusts

Gifting technique that can be utilized to transfer house (usually a vacation home – but can be primary residence) to donor’s children at a discounted value

It’s an irrevocable trust to which the house is transferred and donor reserves right to live in the house for a term of years, with either the children owning the house outright at donor’s death or in trust

Grantor trust

If house sold, QPRT can be converted to GRATSlide168

ILITS

Basic planning points

Death benefits held at death

Allows use of grantor’s gift tax exemption and GSTT exemption amount

Multiple beneficiaries can have interest in death benefits

Draft with flexibility in mind

B233Slide169

ILITS – Accomplishing Flexibility

Donor powers

Change beneficiaries that will receive

Crummey

powers

Use tiered

Crummey powersBeneficiaries holding contingent remainders can have a vested interest in ILITSlide170

ILIT Drafting Provisions

5 and 5 power applied to entire ILIT

Ordering rule for donee holding mutiple withdrawal rights

Special powerholder with limited power to appoint trust property during grantor’s lifetimeSlide171

Beneficiary Powers

Testamentary limited powers of appointment in beneficiaries

Power of grantor, grantor’s spouse and beneficiaries to change trusteeSlide172

Trustee Powers

Discretion to satisfy

Crummey

notice requirements

Crummey

powers satisfied against all trust property

Allow trustee to appoint guardian for minors likely to receive Crummey withdrawal rightSlide173

Estate of TurnerTransferred FLP assets were included in the decedent’s gross estate.

Court also addressed the issue of whether the decedent’s payment of life insurance policy premiums were subject to the annual exclusion under Section 2503(b).Slide174

Estate of Turner

Sloppy

Crummey

gifting

Decedent was grantor of irrevocable life insurance trust that had purchased three separate life insurance policies.

In 2000-2003, the decedent paid the insurance premiums directly from a joint checking account instead of transferring money to the trustees to pay the premiums.

Corporate Buy-Sell Agreements

Entity purchase agreement

Contract between stockholders and corporation

Cross purchase agreement

Contract between stockholders

Hybrid agreements

Contract between corporation and stockholders whereby stockholders agree to offer their shares first to the corporation and then to other stockholdersB234Slide176

Advantages of Buy-Sell Agreements

Prevention of the sale of stock outside the family unit

Relatively simple

Creates a ready market for the stock

Remedies a liquidity problem

Can help set a value for stockSlide177

Disadvantages of Buy-Sell Agreements

Hybrid type agreement may pose difficult tax issue

Must meet technical requirements of Sec. 302(b) or Sec. 303

Less tax problems with cross-purchase agreements

B236Slide178

Buy-Sell Agreement and Life Insurance