Investing for the Future: Managing the Risk, Maximizing the Value. Disclosures

Transcription

1 Investing for the Future: Managing the Risk, Maximizing the Value Disclosures Lawrence Barrett is an employee of Independent Pharmacy Consulting Group, LLC. The conflict of interest was resolved by peer review of the slide content. Thomas Craft is an employee of Independent Pharmacy Consulting Group, LLC. The conflict of interest was resolved by peer review of the slide content. 1

2 Learning Objectives Summarize the necessary components of the planning instruments, i.e. buy-sell agreement, wills, trusts. Discuss the process of planning for business succession Best practices for calculating, evaluating and adjusting financial investment strategy to cover projected and unanticipated developments. Your Presenters For Today s CE Presentation Lawrence C. Barrett, CLU, ChFC, AEP With 44 years of experience in financial services industry, Larry graduated from Ohio Northern University in 1971 with a Bachelor of Science in Business Management and Marketing. Larry has worked with Independent Pharmacies since the late 1970s. He partnered with Tom in 2013 to expand the services offered to his pharmacy clients. Larry is frequent CE speaker for Cardinal Health, NCPA, buying groups, and state pharmacy associations. Larry also speaks to pharmacy students on becoming successful business owners. Thomas H. Craft, CPA, PFS, AEP With over 36 years of experience in financial services industry, Tom career began in public accounting at Deloitte. He subsequently held management positions in Industry. In 1994, Tom formed Artista Financial Group and later, Gateway Financial Advisors to focus on helping business owners maximize the value of their business and protect their wealth for themselves and their family. He partnered with Larry in 2013 to provide tax strategies and financial expertise to independent pharmacy owners. Tom is frequent CE speaker for Cardinal Health, NCPA, buying groups, and state pharmacy associations. This seminar is for informational purposes. All situations are different and this seminar does not have regard to the specific planning objectives, financial situation and the particular needs of any specific person who may view this seminar. The examples in this presentation are hypothetical for illustrative purposes. Tax Reduction Strategies presented are provided for informational purposes. 2

3 Investing for the Future: Managing the Risk No Business Succession Plan? Are There Risks? 3

4 When Do You Begin Managing Risk GOOD 5 10 Years prior to Exiting Your Business BETTER Today, whether your plan are to sell or keep your pharmacy or if undecided BEST On the day you purchase or start your Pharmacy WHY? 4

5 Are You Truly Successful? Achievement vs. Success Is Your Estate in Order? Dying Intestate Dying with a Will 5

6 Is Your Estate in Order? Durable Power of Attorney Healthcare Directives Living Will Healthcare POA Is Your Estate in Order? Inter Vivos Trust (or Living Trust) Testamentary Trust (or Trust under a Will) 6

7 Five Steps to Managing Risk Owner s Goals Explore Options Other s Goals Management Transition Business Assessment Business Owner Involvement Legacy Income Investment Values & Beliefs Goals 7

8 Other Stakeholder s Family Owners Managers & Employees Goals Business Assessment Financial Analysis SWOT Analysis Entity Selection Business Valuation 8

9 What would you sell your business for? $ Now, what would you buy it back for? $ Business Ownership What type of entity do you have for your pharmacy and real estate holdings? Why do you select that type of entity? 9

10 SWAT Analysis SWOT Analysis 10

11 PEST Analysis Investor-Ready Financials What is a financial statement or report? A formal record of the financial activities and position of a business entity or individual that presents the financial information of the business entity or individual in a clear and concise manner that adheres to GAAP. Financial statements include: Income Statement (Profit & Loss Statement) Balance Sheet Cash Flow Statement 11

12 Tracking Trends Description Prescription Sales 91% 92% 92% All Other Sales 9% 8% 8% Total Sales 100% 100% 100% Prescription Costs 71.0% 71.9% 70.5% All Other Costs 5.8% 5.2% 5.5% Total Cost of Goods Sold 76.8% 77.1% 76.0% Gross Profit Margin 23.2% 22.9% 24.0% Payroll Expenses 13.7% 13.4% 14.5% Total Operating Costs 20.2% 20.0% 21.0% Net Profit 3.0% 2.9% 3.0% Source NCPA Digest Manage Assets / Control Debt Managing Cash Flow 4.0% / 1.66% Current Ratio: (Current Assets Current Liabilities) Quick Ratio: (Cash + A/R Current Liabilities Inventory Control 11.1 times / 33 days Inventory Turnover (Annual): (COGS Inventory Turnover (Days): (365 Asset Efficiency 4.9% / 20.2% Sales to Assets: (Total Sales Return on Investment: (Net Profit Debt Management 0.41% Debt to Equity (Net Worth): (Total Liabilities Net Worth) Average Inventory) Inventory Turnover) Total Assets) Net Worth) 12

13 Management Transition Critical when you intend to retain ownership of (or in) your pharmacy 5 step process: 1. Assess your responsibilities, skills and relationships. 2. Assess your management team s skills and abilities especially potential successors 3. Gain insight into your successor(s) / management teams goals for their future 4. Determine needs and provide training for your management team / successor(s) 5. Balance the needs of your management team / successor(s) with new responsibilities Explore Options A business often dies when it s owner dies or becomes disabled not because something was done wrong, but because nothing was done at all. 13

14 Buy-Sell Agreement (2 or more owners) Purpose: 1. Maintain continuity of your business ownership 2. Protect value of your business 3. Protect your spouse and family 4. Avoid conflicts and financial stress between shareholders and decedent shareholder s heirs 5. Determine valuation of business and funding upon occurrence of shareholder death, disability, divorce, bankruptcy, retirement, etc. 6. Create stability to retain employees, customers, and vendors Types of Buy-Sell Agreements Wait and See Stock Redemption Cross Purchase 14

15 One-Way Contingency Plan Purpose: 1. Maintain continuity of your business ownership 2. Protect value of your business 3. Create financial stability for your spouse / family 4. Develop game plan for immediate impact of catastrophic event such as death or disability 5. Develop six-month plan to maintain pharmacy operations with management team until pharmacy can be sold 6. Create stability to retain employees, customers, and vendors Investing for the Future: Maximizing the Value 15

16 Takeaway # 1 Tax Planning is more important than ever. Taxes have increased and are expected to increase as federal deficits continue to grow and interest rates rise. Takeaway # 2 The Federal Tax Code is 74,608 pages, complex and overwhelming. Using the Tax Code properly can provide many tax reduction strategies that may save you hundreds, thousands, and even millions of dollars. 16

17 Takeaway # 3 You must engage the services of a tax professional proactive in identifying tax reduction strategies and opportunities. Proactive Reactive Inactive The accountant is the brave soul that comes onto the battlefield after the battle has been fought and counts the dead and bayonets the wounded Two Dimensional Tax System Regular Tax YOU AMT 17

18 REGULAR TAX: 2016 Income Tax Brackets $415,050 35% $466,750 $413,350 $190,150 $91,150 $37,650 <$9,275 Single 33% 28% 25% 15% 10% $413,350 $231,450 $151,900 $75,300 <$18,550 Married, Joint REGULAR TAX: Capital Gains Tax Brackets 35% 33% 28% 15% Capital Gain Rate 25% 0% Capital Gain Rate 15% 10% 18

19 Form 1040, Page 2 Five Dimensional Tax System Regular Tax NIIT AMT YOU Super Tax Pease / PEP 19

20 PEASE PHASEOUT: Itemized Deductions Phase Out begins: $259,400 (single) $311,300 (MFJ) PEP PHASEOUTS: Personal Exemptions PEP reduces personal exemptions for taxpayers and dependents by 2% for each $2,500 (or fraction thereof) of income above the threshold amount for single and married taxpayers filing jointly. 2% for each $1,250 (or fraction thereof) of income above the threshold amount for married taxpayer filing separately. 20

21 The New Super Taxes Employment Taxes Medicare Add on Tax 0.9% tax rate No upper limit $200,000 single $250,000 MFJ 0% Capital Gain Rate 39.6% 35% 33% 28% 25% 15% 10% 15% Capital Gain Rate 20% Capital Gain Rate 3.8% Net Investment Income Tax (NIIT) Single Estate / Trust MFJ $200,000 $12,300 $250,000 Net Investment Income Tax Threshold Amounts Income subject to NIIT Taxable Interest Dividends Rental Income Annuity Distributions *Passive Income (ordinary income) **Net Capital Gains (passive investment) Royalties Income exempt from NIIT Salary/Wages IRA Distributions Tax-Exempt Income Self-Employment Income *Business Income (S Corp/LLC) **Gains on Sale of Active Interest (Pass-Thru Entity) 21

22 20% Capital Gain Rate 3.8% Net Investment Tax AMT $189,300 $90, Total Tax Picture >$413, % >$464,850 $413,200 $411,500 28% 26% 35% 33% 28% 25% $464,850 $411,500 $230,450 15% Capital Gain Rate $151,200 Pease / PEP $37,450 <$9,225 Single 0% Capital Gain Rate 15% 10% Medicare Add on Tax 0.9% <$18,450 MFJ $74,900 How Tax Friendly is Your State? 22

23 2016 State Income Tax Rates Investments Municipal Bonds Master Ltd. Partnership REITs Statutory Tax Shelters 401(k) / Simple IRA IRA / Roth IRA Deferred Annuities Tax Strategy Toolbox Legal Documents Charitable Remainder Trust Charitable Lead Trust Intentionally Defective Income Trust Asset Location Taxable Tax Deferred Tax Free 23

24 Tax Reduction Strategies Choice of Entity Tax Aware Investing Retirement Plans Sec Exchange Personal Goodwill S Corp Exit Plan Income Smoothing Bracket Management Income Shifting Tax Favored Cash Roth Conversion Charitable Planning CHOICE OF ENTITY 24

25 ENTITY OPTIONS S C LLC SP P Are You Overpaying Employment Taxes? Mike is 100% owner and active in running his pharmacy. He employs 7 people and is organized as an Single Member LLC*. He reports $330,000 in net profit on which he pays Social Security (up to $118,500) and Medicare taxes (unlimited). Current (SMLLC) Income Source $ Guaranteed Wages 120,000 Net Profit 210,000 Total 330,000 Revised (S Corp) Income Source $ Wages 120,000 Net Profit 210,000 Total 330,000 Employment Tax $ Social Security* 14,694 Medicare Tax 9,570 Addt l Medicare 1,170 Total 25, % Owner SMLLC Materially Participates * C Corp. has similar results Employment Tax $ Social Security* 14,694 Medicare Tax 3,480 Addt l Medicare 0 Total 18,174 25

26 CHOICE OF ENTITY All Profits subject employment tax LLC/SP Social Security tax (12.4%) limited Medicare tax (2.9%) unlimited Additional 0.9% over $200k / $250k Double Taxation C Goodwill Tax Reduction $7,260 annually $72,600 (10 yrs.) TAX AWARE INVESTING 26

27 Congressional Incentives for Oil & Gas Development Oil & Gas Development Internal Revenue Code not a tax loophole Congress quest for energy independence Intangible Drilling Costs / Depletion / Deprec. Costs incurred to drill and complete well May range from 70 85% of total cost to drill Functional Allocation Amount of cost allocated to investor May range from 80 95% tax deduction. Passive Loss Rules / AMT 27

28 Example George has taxable income of $1,500,000 and decides to invest $250,000 into an oil & gas investment. Total Investment $250,000 Cash Outlay $160,000 Tax Savings $90,000 Cash Outlay Recouped 5 6 yrs. $160,000 Total Invest. Recouped 8 9 years $250,000 Investment Returns Continue years Returns from each well may vary. TAX AWARE INVESTING Use IDCs to shelter taxable ordinary or passive income or the taxable proceeds from the sale of your pharmacy or real estate Utilize suspended passive losses by creating passive income to generate tax free cash flow Oil & Gas $90,000 annually 28

29 RETIREMENT PLANS Interested in maximizing your 401(k) Plan contributions? 29

30 Safe Harbor 401(k) Plan Owner can contribute the maximum annual deferral amount of $18,000 (plus $6,000 if > 50 years old). Owner receives additional savings from company matching contributions To avoid the IRS non discrimination (ADP/ACP) tests: Elective: 100% of employee elective contribution on first 4% of compensation; or Non Elective: 3% contribution of compensation for all eligible employees Interested in additional tax deductions and increased retirement savings? 30

31 Cash Balance Plan Hybrid Plan DEFINED BENEFIT PLAN TRAITS Annual actuarial calculations. Participant s account credited with a set percentage of yearly compensation plus interest charges. Employer assumes investment risk. DEFINED CONTRIBUTION PLAN TRAITS Value of benefits determined on an individual account basis (but are not segregated into individual accounts). Cash Balance Plan example Peter is looking to increase his retirement savings but also wants to reduce his annual income tax liability. He sets up a Cash Balance Plan in conjunction with his Safe Harbor 401(k) Plan. Employer Employer % of Name Age Pay 401(k) Safe Harbor Cash Balance Total Pay Owner 56 $265,000 24,000 13,000 $182,850 $219, % Employee ,000 1,800 1, , % Employee ,000 3,275 2,010 1,005 6, % Employee ,000 1,900 1, , % Employee , ,640 1,320 3, % Employee ,000 3,400 2,370 1,185 6, % Employee ,000 3,000 1, , % TOTAL 659,000 37,375 24, ,760 $250,955 Contributions to Employees 11,820 5,910 17,730 Contributions to Owner 13, , ,850 % of Contributions to Owner 92.0% 31

32 RETIRMENT PLANS Safe Harbor 401(k) Plan Maximize 401(k) contribution Cash Balance Plan Owner receives 92% of total contributions Employer Tax Deduction $213,580 Owner Retirement Savings $219, LIKE-KIND PROPERTY 32

33 Outright Sale of Real Estate Original Cost $500,000 Improvements 100,000 Less Depreciation (148,000) Taxable Basis $452,000 Sales Price $1,000,000 Taxable Basis 452,000 Taxable Capital Gain $548,000 TAX CALCULATION Capital Gain Deprec. 25% $37,000 Long term Capital 20% 80,000 Total Federal Tax $117,000 Seller is left with only $883,000 to reinvest 1031 Like Kind Property Defined Any property used in a trade or business or as an investment including planes, boats and vehicles but most often associated with real estate or land. Condos or Apartments Single Family or Duplexes Industrial Property Commercial Property Retail Property Raw Land 33

34 1031 Like Kind Property Defined The use by the taxpayer i.e. investment, business, or trade is more critical then the type of property. The following is not considered likekind property: Stock in trade or property held for sale Stocks, bonds or notes Inventory Personal residence Construction or fix/flips for resale Partnership or LLC member interest The 1031 Exchange Timetable The critical time limits at work here are: 3 parties (usually): exchanger/buyer/seller Facilitated by a qualified intermediary. 45 day rule / 180 day rule (no extensions) Time limits begin to run on the date the exchanger transfers the relinquished property to new buyer The date of transfer is the date of recording or transfer of the benefits and burdens of ownership 34

35 The 1031 Exchange Mechanics BUYER TAXPAYER Relinquished Property Replacement Property Relinquished Property Replacement Property QUALIFIED INTERMEDIARY Cash Cash SELLER 1031 LIKE-KIND PROPERTY Original Cost $500,000 Improvements 100,000 Less Depreciation (148,000) Taxable Basis $452,000 Relinquished Replacement Taxable Example Property Property Gain Replacement Value Greater $1,000,000 $1,200,000 $0 Replacement Value Less $1,000,000 $950,000 $50,000 Seller pays no capital gains and invests the full value of the property 35

36 PERSONAL GOODWILL Why is Personal Goodwill Important? C Corporation $2,000,000 S Corporation $2,000,000 Corporate Tax $763,250 Personal Tax (C Liquidation) $247,350 TOTAL TAX LIABILITY $1,010,600 Personal Tax (S Pass Thru) $400,000 Difference in Tax Liability $610,600 36

37 Personal vs. Enterprise Goodwill Reputation Expertise Skill Knowledge Relationships with Customers Answer the following questions (sample): How involved are you in the day to day operations of your pharmacy? What percentage of the Pharmacy s revenues are attributable to your efforts? Would pharmacy profits decline considerably if you were not there? How much? What are the reasons why customers are attracted and retained by the Pharmacy? Personal Goodwill Requirements Two Important Steps Personal Goodwill Appraisal Personal Goodwill Purchase Agreement 37

38 Personal Goodwill Example C Corporation Sale Price = $3.25M Inventory $500,000 Fixed Assets $150,000 Goodwill $2,450,000 Restricted Covenant $150,000 Personal Goodwill $1,100,000 Corporate Goodwill $1,350,000 PERSONAL GOODWILL Elect S Corporation Status 5 Year BIG Tax Pass Through Entity Capital Gains Tax Savings $751,000 C Corporation Personal Goodwill Personal Goodwill Capital Gains Tax Savings $299,000 38

39 EXIT PLANNING: A Real Case Exiting an S Corporation (5 strategies) Year of Asset Sale 2014 Asset Sale Price $2,125,000 Capital Gains Portion 1,080,000 Adjusted Gross Income 2,023,922 Itemized Deductions 94,515 Less: 3% AGI Limitation 51,566 Taxable Income $1,980,973 Pharmacy 2015 Tax Liability $13, Tax Liability $519,434 39

40 Step #1: Reduce Restricted Covenant Purchase Price Allocation Inventory $325,000 Fixed Assets 1,000 Restricted Covenant 719,000 Goodwill 1,080,000 Total Purchase Price $2,125,000 Seller saves $52,724 Purchase Price Allocation Pharmacy Restricted Covenant is reduced by $269,000 Restricted Covenant 450,000 Goodwill 1,349,000 Step #2: Defer State Income Tax Payment 2014 Itemized Deduction State Income Tax Paid $94,515 Less: 3% AGI Floor 51,566 Total Deductions 42,949 Pharmacy 2014 Itemized Deduction State Income Tax Paid $1,690 Less: 3% AGI Floor 1,352 Total Deductions Itemized Deduction State Income Tax Paid $92,825 Less: 3% AGI Floor 0 Total Deductions 92,825 40

41 Step #3: Maximize IRA Contributions 2014 IRA Contribution Taxpayer 1 $6,500 Taxpayer 2 6,500 Total Deductions $13,000 Pharmacy Seller saves $5, SEP IRA Taxpayer 1 $23,400 Taxpayer 2 6,500 Total Deductions $29,900 The additional tax savings from the SEP IRA is more than offset by cost of contributing 3% to employees Step #4: Shelter Taxable Gain on Sale Purchase Price Allocation Taxable Income $2,044,599 Deduction* $188,000 Adjusted Tax Income $1,816,599 Pharmacy Seller saves $77,448 Investment Strategy Energy Master L.P. Investment $200,000 First Year Tax Deduction 188,000 Actual Cash 45% $115,400 * Deductions result from intangible drilling costs (IDCs), depletion and depreciation costs. 41

42 Step #5: Roth IRA Conversion Purchase Price Allocation State Tax Deduction $92,825 Roth IRA Conversion* $92,825 Conversion subject to federal tax $0 Seller saves $19,000+ * The Roth IRA grows tax deferred. All withdrawals in retirement are tax free. Pharmacy EXIT PLANNING For S Corporation 1. Restricted Covenant 2. State Tax Deduction Phase out 3. Maximize Retirement Account 4. Shelter Taxable Gain 5. Roth Conversion Total Tax Savings $192,619 42

43 Thank You Presented By: Independent Pharmacy Consulting Group, LLC lawrence C. Barrett CLU, ChFC, AEP Chagrin Blvd., Suite 300 Cleveland, OH Tele: Thomas H. Craft CPA, PFS, AEP 7007 Sprague Road Cleveland, OH Tele: