TAKE THE WHEEL. Planning for the Financial Future of Your Auto Dealership LASTING LEGACY

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1 TAKE THE WHEEL Planning for the Financial Future of Your Auto Dealership STAY ON TRACK FAMILY SUCCESSOR NON-FAMILY SUCCESSOR WEALTH PROTECTION PLANNING PITFALLS ENHANCE LIQUIDITY ESTATE TAXES REAL ESTATE LASTING LEGACY INCOME TAXES Auto dealers have unique needs for succession planning. Here s a few strategies to consider. BY SEAN GILLIA, U.S. Trust Investment products: Are Not FDIC Insured Are Not Bank Guaranteed May Lose Value SEE LAST PAGE FOR ADDITIONAL INFORMATION.

2 YOUR BUSINESS 2 FOR AUTO DEALERS, like most entrepreneurs, business ownership is often a life long labor of love. The ability to create something out of nothing and sustain it over time is a remarkable accomplishment that demands courage, hard work, perseverance and often personal sacrifice and financial risk along the way all driven by the belief that the personal and financial rewards will be worth the effort. Yet for all the time auto dealers devote to starting and growing their businesses, they tend to give surprisingly little attention, by comparison, to how and when they will make their exit and that s true on both the business and personal sides of the wealth planning coin. OPENER: ISTOCK.COM Often, it s simply the case that the day-to-day demands of running a business take precedence over creating and maintaining business succession and wealth transfer plans. While this is certainly understandable, putting off important planning can be risky, particularly since planning for auto dealership owners presents a number of quirks and complexities. In many instances, planning professionals don t enter the picture until some unforeseen event illness, disability, divorce, death or a change in financial circumstances disrupts daily business, at which point circumstances may become stressful and options limited. Early planning including estate planning, asset protection and business succession is critical and can make a meaningful difference in the amount of wealth you ultimately create and retain for yourself and your family. Holly Swan and Robert P. Goodman, senior wealth strategists at U.S. Trust, both have extensive experience working with auto dealership owners. In this article, they discuss the top concerns of auto dealers and the various strategies for addressing them. HOW DO I TRANSFER MY BUSINESS TO A FAMILY MEMBER? Establishing a succession plan as early as possible is important. This is true for all businesses, Goodman says, but it s especially important for auto dealers, since auto manufacturers often impose certain requirements on the process. Transferring ownership from one family member to another can be complicated because it comes with a number of psychological as well as business challenges. It requires that the current owner (generally a parent) be willing to cede some form of control to the new owner (usually their child or children). It also includes the process of selecting who you think would be the best person to take control, which may be emotional and challenging. Proactive business succession planning not only helps in the process of identifying potential successors but also facilitates and prepares them to take over the business in terms of skills, knowledge and financial readiness. Beyond choosing a successor, key financial issues must be addressed. One of the first considerations must be the impact on your wealth and cash flow, Goodman says. If the company is transferred by gift, you must also be concerned with the impact of any gift tax liability. The tax laws currently allow you to give up to the cumulative amount of $5.43 million ($10.86 million for a married couple) of taxable gifts during your life without paying gift taxes. Once that amount is exceeded, then a gift tax will be due in the amount of 40% of the excess. One strategy that can help minimize the gift-tax liability is to sell the company instead of gifting it, he says. This eliminates any gift tax, but raises other potential issues. If you sell the company to family members, they must have the cash (or financing) to acquire it, while you must have sufficient cash to pay any capital gains taxes triggered by the sale. In these instances, Insurance and Irrevocable Life Insurance Trusts (ILITs) are sometimes used as funding aids. A well-thought-out succession plan can help ensure that the full value of the assets tied up in your dealership are realized, providing financial security now and in the future, and making sure your wishes for the continuity of the business meet your business and personal goals.

3 YOUR BUSINESS 3 PHOTOGRAPH BY BTRENKEL/GETTY IMAGES A WELL-THOUGHT-OUT SUCCESSION PLAN CAN HELP ENSURE THAT THE FULL VALUE OF THE ASSETS TIED UP IN YOUR DEALERSHIP ARE REALIZED. HOW DO I TRANSFER MY BUSINESS TO A SUCCESSOR OUTSIDE MY FAMILY? If you re planning to sell to an outside company or individual, you should examine the tax ramifications of selling stock in the company versus selling the company s assets, or some combination of the two, says Swan. Many times selling stock will result in lower income taxes. You might also consider possible non-compete or consulting agreements with your potential buyers, as that can be an additional source of value or cash. If you re thinking about selling your business to partners or co-owners, certain risks could cause significant disruption for you and also threaten the value of your business, she says. These risks are commonly known as the 5 Ds that is, death, disability, divorce, departure (if an owner leaves the business) and default any one of which could conceivably scuttle a planned sale. One method of protection is a pre-established buy-sell agreement among co-owners that would be automatically triggered by specific events, such as one or more of the 5 Ds. Says Goodman: A buy-sell agreement establishes protocol for the sale of one of the owner s interest in the company if the owner dies, is forced to leave, say, as a result of disability, or even chooses to leave the business. To ensure that the remaining owner or owners will be able to purchase the company when the time comes, and to prevent any business-side disruptions, buy-sell agreements should be fully funded. Life insurance can fund a buyout plan in the event of an owner s death, but maintaining that insurance as the business grows can sometimes become prohibitively expensive, he notes. Other funding mechanisms include using earnings from the business, if the business can support it, borrowing, or using personal assets. HOW CAN I AVOID PLANNING PITFALLS? Assuming you ve established various entities to allow for succession and estate planning, you can still get tripped up in several ways. Planning can be voided, for instance, if formalities such as meetings, note keeping and other records are treated erroneously or not kept, or if the financial structure created by the various entities is not respected, says Goodman. For auto dealers with multiple locations, it is important to plan in phases and keep the entitynaming mechanisms simplified to allow for easier record keeping and documentation, he continues. Consider using Delaware Dynasty Trusts and separate operating businesses from real estate. Also, do not give away more than you can afford. Planning for your own financial needs should be done prior to implementing any gifting plan. HOW DO I REDUCE ESTATE/GIFT TAXES? By transferring ownership of your dealership during your lifetime, you can reduce estate taxes. You can deal with this in part by making lifetime gifts using the annual exclusion ($14,000 per person per year) and the lifetime gift tax exemption ($5.43 million), says Swan. However, she points out that many owners aren t interested in retiring or giving up control of their business. In this case, you can separate ownership and control through voting and nonvoting stock. You can gift nonvoting shares, which may be eligible for certain valuation discounts (such as for lack of control

4 YOUR BUSINESS 4 or lack of marketability) directly to family members or into trusts for their benefit, and still retain control by keeping voting shares for yourself. It should be noted that in August 2016, the IRS proposed new regulations that may affect valuation discounts in the future. Using certain trust structures to transfer assets out of your estate can create additional tax advantages. The most popular are Grantor Retained Annuity Trusts (GRATs) and Intentionally Defective Grantor Trusts (IDGTs). With a GRAT, you are making a gift of future appreciation (above a typically low hurdle rate ), assuming there is any, into a trust and gradually taking back the principal (the amount you started with) over the life of the trust. IDGTs work similarly, and basically deal with two sets of IRS rules individual income tax rules and IRS transfer tax rules (estate, gift, generation-skipping, etc.). It s impossible to sell an asset to yourself and have it be a taxable transaction for income tax purposes. For transfer tax purposes, however, it is possible to sell an asset to a trust, and if that trust has some special provisions, for transfer tax purposes, that sale is a real and recognized event. As with a GRAT, you eventually receive your principal back, but any appreciation (above the hurdle rate) would be out of your estate. HOW CAN I REDUCE MY INCOME TAXES? Income tax liability is a common concern among auto dealers, especially with the rise in tax rates and the new 3.8% Medicare surtax. Among other things, reduced after-tax earnings mean less money for reinvesting in the business or meeting cash flow needs. CASE STUDY: INTEGRATING SUCCESSION AND ESTATE PLANNING A successful auto dealership owner overseeing multiple dealerships for a broad range of auto manufacturers, this client continued to take an active role in identifying, evaluating and buying additional dealerships, even as he entered his seventies. When a manufacturer asked him for an after death clause (or business succession plan) before selling a dealership to him, he realized that he had no formal strategy for transferring his business. THE APPROACH The client s U.S. Trust wealth strategist evaluated his estate plan and drew up a document to show how assets would be distributed after his death. The client immediately identified a number of problems with the stipulations (for example, it did not reflect his youngest son s growing role in the business) and began exploring modifications. Open-ended discussions about the client s values, family, business and legacy became the basis for an integrated business succession and estate planning strategy. Business continuity was a crucial concern. The client asked U.S. Trust to help him ensure that the dealerships would continue to be run by his operating managers after his death. Philanthropy was also important. The client wanted to achieve his philanthropic goals during his lifetime, yet overseeing his charitable endeavors had become increasingly time-consuming. THE SOLUTIONS The client s U.S. Trust team worked with the client s attorney to create a succession planning strategy that met the manufacturer s requirements for an after death clause. It provided detailed information about who would take over the business if the client died or was no longer able to manage it. He was able to complete the purchase of a new dealership and went on to buy three more dealerships in the two years that followed. U.S. Trust assisted the client in creating a management committee responsible for making operating decisions for the dealerships in the time between the client s death and the eventual settlement of the estate. The development of a succession strategy to ensure continuity of his business and role clarity for his chosen successors contributed to his comfort. At the same time, the U.S. Trust team developed an estate planning strategy that directed the distribution of all his assets, both inside and outside the business. The integration of his estate planning and succession planning provided for the financial security of a large, multigenerational family. Working with U.S. Trust specialists, the client established a $50 million private foundation, allowing him to focus his support on the charities he valued most. With U.S. Trust s philanthropic specialists easing his admini strative burden, he was able to take a more active role in making grants.

5 YOUR BUSINESS 5 Investment solutions may be available to potentially lower your overall income tax liability by actively harvesting tax losses that can offset capital gains, Goodman says. Also, structuring sale transactions through certain trusts could be a way to avoid state income taxes on the sale of low-basis assets. HOW CAN I CREATE A LASTING LEGACY? Not unlike most professionals in any other industry, auto dealers want to provide for future generations grandchildren and beyond while minimizing transfer tax consequences. Often, grandchildren are too young to be actively involved in running a business, and outright gifts to future generations, if they re even alive yet, tend to be regarded as inadvisable. One possible approach is a Generation-Skipping Tax (GST) Exempt Trust capable of holding assets for a long period of time, says Goodman. In this case, your children would not receive the assets, thus avoiding any estate taxes that would apply if the assets were transferred to them, and the assets would instead be available to future generations. These trusts can be used in combination with other trust planning techniques, such as a sale to an IDGT, he adds. Beyond the GST exempt trust, you might also consider creating an ethical will to make sure future generations understand your philosophies of wealth and how the family wealth was created, he says. HOW DO I PLAN FOR MY REAL ESTATE? Auto dealers are often torn between transferring real estate assets outside of their taxable estate during their lifetime versus keeping the assets in their estate to achieve a basis step-up at death. That is, when you give property to someone in the event of your death, the beneficiary receives it with a cost basis equal to the then current value of the property, rather than the value at the time of purchase. Says Swan: In many cases, real estate was purchased early on for a low price and may have been further depreciated. Auto dealers may choose not to gift these assets because of the built-in capital gains consequences. For such low or negative basis real estate, you might consider gifting the low basis assets to an IDGT and later swapping or exchanging them with cash or other high-basis assets. HOW CAN I ENHANCE LIQUIDITY TO IMPROVE MY BUSINESS? Having liquidity tied up in the dealership or in other tangible assets can prove challenging sometimes impossible to auto dealers looking to expand or improve their business. Moreover, estate and succession planning may be postponed because of the potential loss of cash flow and lack of out side assets to generate replacement funds. One possible way to provide financing for aspects of the business and to free up cash flow on your balance sheet is to consider custom loans or lines of credit, says Swan. Both of these can be useful in building, diversifying and transferring wealth and acquiring assets. Also, a loan solution could eliminate or defer an otherwise taxable event, and interest on a loan that is used in a trade or business can be deducted as a business expense with no limitations. HOW CAN I PROTECT MY WEALTH FROM CREDITORS? Professional and liability insurance is the first step, says Swan. But you can take additional actions to help insulate your business and personal assets from the claims of creditors. CONSIDER CREATING AN ETHICAL WILL TO MAKE SURE FUTURE GENERATIONS UNDERSTAND YOUR PHILOSOPHIES OF WEALTH. PHOTOGRAPH BY PETER CADE/GETTY IMAGES

6 YOUR BUSINESS 6 For instance, you can consider an asset protection trust. A number of states allow you to transfer assets to a trust and protect them from creditors even if you are a beneficiary of the trust. In general, to work, the trust has to be irrevocable, it can t require that any part of the income or principal of the trust be distributed to the grantor (the trust s creator), and it can t have been created to hinder, delay or defraud known creditors. In other words, she says, these plans need to be established well in advance of any actual claims. Planning done after a claim arises may be considered a fraudulent conveyance and can have serious consequences. Asset protection is also afforded to the share holders of corporations, CASE STUDY: CREATING LIQUIDITY TO MEET ESTATE-TAX LIABILITIES WITHOUT SELLING A BUSINESS A businessman who owns auto dealerships in two states, this client has used proceeds from selling some dealerships to acquire substantial agricultural and commercial real estate interests. As he entered his eighties, he became concerned about how his estate could meet estate tax liabilities after his death with-out a forced sale of some of his business interests. THE APPROACH A key factor for this client was that estate taxes on commercial real estate investments are due much sooner than estate taxes on qualifying active businesses. Based upon the value of his commercial real estate investments, his CPA estimated that nine months after his death he could owe $50 million in estate taxes. Our client had $17 million in liquid assets at the time and was looking for ways to reduce estate taxes and create liquidity. He did not want his family to be forced to sell assets to meet estate taxes. The client s U.S. Trust wealth strategist reviewed the existing estate plan and trust documents, while his advisor and wealth strategist worked with a U.S. Trust credit specialist to analyze the commercial real estate properties and put together a real estate loan proposal. The advisor also introduced the client to Bank of America s Commercial Banking Agriculture group to see if they could improve the terms or increase the credit facility size on an existing Farm Credit loan he had on his agricultural property. In addition, the advisor introduced the client to a portfolio manager, who analyzed the existing $17 million municipal portfolio managed by another private bank. THE SOLUTIONS Upon the recommendation of the wealth strategist, the client worked with his estate planning attorney to create a grantor trust, and opened six individual sub-trust investment accounts at U.S. Trust to hold the gifts of commercial real estate he has made to his children. Because this was a private transaction, the property was eligible for discounting techniques, which would reduce the value of the assets in the client s estate. The CPA estimates that the client s estate taxes will drop by around $10 million. However, it is important to note that the IRS has issued proposed regulations that may affect such valuation discounts in the future. The Commercial Banking Agriculture group proposed refinancing the existing $25 million Farm Credit loan with a new $40 million Bank of America loan, the structure of which also included a $20 million interest rate swap. This proposal was more compelling than the prospective real estate loan. Based on his team s recommendations, the client asked the Commercial Banking Agricultural Group to refinance the existing loan. The portfolio manager highlighted some concentration and credit risks in the municipal bond holdings and also noted that the existing duration of the portfolio was inappropriately long given the stated purpose of using funds to pay estate taxes. The portfolio manager recommended restructuring the municipal holdings to better diversify and to reduce the overall duration. The client moved his existing municipal portfolio to U.S. Trust. When the agriculture loan refinance closed, he added the $15 million from increased loan proceeds to the municipal portfolio. He subsequently added incremental funds from operating cash flow, eventually bringing the portfolio to $40 million now sufficient to cover the estate tax liability.

7 YOUR BUSINESS 7 the limited partners of limited partnerships, and to members of limited liability companies, notes Goodman. So you may want to consider establishing your dealership as one of these entities, if you haven t done so already. HOW DO I KEEP MY PLANNING ON TRACK? Auto dealers aren t always sure about how to begin the planning process. When it comes to succession planning, they tend to begin planning too close to the liquidity or transfer event to successfully achieve all of their objectives, says Swan. When it comes to asset protection strategies, they may implement them after a claim arises, bringing unwanted and possibly intense scrutiny. First and foremost, both Swan and Goodman agree, you should review your overall financial situation to ensure that you are able to meet your own financial goals and needs. A team of advisors including an appraiser, accountant, private banker, tax attorney and wealth strategist who understand your goals and can work together should be assembled to craft an efficient plan. In this way, you can obtain relevant tax and estate planning advice, calculate your potential income tax liabilities and implement appropriate tax-reduction strategies. Says Goodman: Many options such as life insurance, nonqualified deferred compensation and buy-sell agreements exist to facilitate a successful business succession plan, whether the exit path involves a sale during your lifetime to insiders or a third party, or a transfer at your death. Most important here, adds Swan, is that plans should be made during your lifetime, as the more time you have available to plan, the more likely it is that the selected strategies will be detailed and effective.

8 IMPORTANT INFORMATION Neither U.S. Trust nor any of its affiliates or advisors provide legal, tax or accounting advice. You should consult your legal and/or tax advisors before making any financial decisions. Always consult with your independent attorney, tax advisor, investment manager and insurance agent for final recommendations and before changing or implementing any financial, tax or estate planning strategy. OTHER IMPORTANT INFORMATION Other Nonfinancial assets, such as closely held businesses, real estate, oil, gas and mineral properties, and timber, farm and ranch land, are complex in nature and involve risks, including total loss of value. Special risk considerations include natural events (for example, earthquakes or fires), complex tax considerations and lack of liquidity. Nonfinancial assets are not suitable for all investors. Case studies are intended to illustrate products and services available through U.S. Trust. The case study presented is based on actual experiences. You should not consider this as an endorsement of U.S. Trust or as a testimonial about a client s experiences with us. Case studies do not necessarily represent the experiences of other clients, nor do they indicate future performance. Investment results may vary. The investment strategies discussed are not appropriate for every investor and should be considered given a person s investment objectives, financial situation and particular needs. Clients should review with their U.S. Trust advisor the terms, conditions and risks involved with specific products and services. U.S. Trust operates through Bank of America, N.A., and other subsidiaries of Bank of America Corporation. Bank of America, N.A., Member FDIC Bank of America Corporation. All rights reserved. Date of First Use: October NSB 10% post-consumer content ARWVBJLB