Estate Planning for Business Owners

Transcription

1 Estate Planning for Business Owners Michael D. Whitty I. OVERVIEW OF PRESENTATION Michael D. Whitty concentrates his practice in estate planning, taxation, and estate and trust administration. Mr. Whitty represents business owners, principals of venture capital and private equity funds, key executives, investors, and other high-net-worth individuals in planning for the preservation and transfer of their wealth. Specifically, he advises individuals and fiduciaries in the design and drafting of estate plans, wills, trusts, lifetime gifts, premarital agreements, and other estate planning documents. Mr. Whitty has extensive experience with various types of trusts, family limited partnerships, corporate recapitalizations, shareholders and redemption agreements, private annuities, installment sales, intra-trust sales and other transactions, self-canceling installment notes, and net gifts. He also reviews and manages estate and gift tax returns, including complex reporting and valuation issues. He is a Fellow of the American College of Trust and Estate Counsel, a Fellow of the Family Firm Institute (holding certificates in Family Wealth Advising and Family Business Advising), a member of Attorneys for Family-Held Enterprises, and a member of the Chicago Estate Planning Council. He was an active member in the American Bar Association through August of 2013, in which he served on the Section Council and as Chair of the Wealth Planning and Nontax Issues Group of the Probate and Trust Division in the Section of Real Property, Probate and Trust Law. Mr. Whitty served for three years as an adjunct professor at the Northwestern University School of Law, teaching a course titled Federal Estate and Gift Taxation and Estate Planning. He is a Certified Financial Planning practitioner (CFP ) and a member of the Financial Planning Association of Illinois. Mr. Whitty has been named to Illinois Super Lawyers and Illinois Leading Lawyers. He also received an AV Preeminent Peer Rating in Martindale-Hubbell. Mr. Whitty is a frequent speaker on estate and financial planning topics, appeared on the PBS program Nightly Business Report, and has been quoted in the Wall Street Journal. He can be reached at mwhitty@handlerthayer.com II. This overview presentation will introduce the audience to some of the special issues and challenges involved in estate planning for business owners, including succession planning, equitable planning when not all children are in the business, planning for a future sale of a business, and planning for owners of dealerships, distributorships, and franchises. CHALLENGES AND ATTRACTIONS OF ESTATE PLANNING FOR BUSINESS OWNERS A. Additional Challenges Estate planning engagements for the business owner are more challenging than the average estate plan, with more pitfalls to avoid, but are ultimately more intellectually and professionally rewarding. Compared with an estate planning engagement for an executive who is not a substantial owner of his or her business, with a salary, retirement plan, stock options, investment portfolio, and real estate, the owner of the closely held business typically has all of those issues as well as business succession and exit planning, business governance planning, and business legal issues that may ALI CLE Estate Planning Course Materials Journal 29

2 30 ALI CLE Estate Planning Course Materials Journal February 2016 be only tangentially related to the estate plan but that are identified during the estate planning process. B. Advantages For and Within Your Law Firm Estate planning for the family business owner creates much more opportunity for cross-selling with other practice areas of the firm, including corporate, business income tax, real estate, executive compensation, intellectual property, and litigation. Working with the attorneys in the other practice groups needed for advising the family business owner will develop into positive synergy. Your corporate and income tax partners can help you design the estate plan to avoid pitfalls in their areas, and likewise, you can help your corporate and income tax partners avoid pitfalls in their deal structuring that can trigger gift or estate tax issues (eg. 26 U.S.C. 2701) or future estate and trust administration issues. The family business owner is the kind of client you really want to have! C. The Proper Scope for a Business Owner s Estate Planning Engagement 1. Importance of Seeing the Whole Picture. Before designing and implementing an in-depth estate plan for the business owner, it is essential to identify and understand the limitations and parameters within which the estate planner must work. (a) Many sophisticated estate planning techniques, and even some basic ones, may not always be available to the closely held business owner due to limitations and parameters imposed by the business s structure, tax status, other owners, and contractual arrangements with third parties. (b) Other techniques may or may not be appropriate depending on the owner s ultimate goals for the business, including whether to ultimately sell the business or to transfer the business intact to a successor. 2. Due Diligence Phase of the Estate Plan. Consequently, a comprehensive estate planning engagement for the family business owner must include a due diligence phase to identify all the limitations and parameters that will affect the estate plan. This due diligence phase should be incorporated into the engagement s budget. Anticipating a question the business owner may pose: it will not be more efficient or cheaper to skip the due diligence phase and simply ask questions of the general counsel or primary corporate outside counsel as to whether an estate planning technique will be available or practical. Those other parties will rarely be familiar enough with estate planning techniques to know how to answer the question.

3 Estate Planning for Family Business Owners Balancing Motivation and Caution. It takes skillful communication to get a client excited about the potential benefit of a particular estate planning technique, while cautioning that due diligence is required to confirm the technique is available in that client s case, and getting the work authorized to perform that due diligence. Planners should expect clients to be fee-sensitive about due diligence work that leads to the conclusion that a technique is not available. Consider setting a fixed fee arrangement for such due diligence and, as part of the agreement, obtaining the client s consent to pay regardless of the conclusion reached. D. Dealing With the Business Owner Who Insists on a Simple Estate Plan Occasionally, a business owner client may insist that he or she needs only a simple core estate plan (a revocable trust, pour-over will, powers of attorney, and some ancillary documents). If the business owner insists on limiting the scope of your engagement to the core estate plan, then (i) within your engagement letter or a side letter establish that limiting the scope of the engagement to a core estate plan was the client s choice, despite the attorney s recommendation for a broader engagement to address the client s business issues related to estate planning, (ii) get the core plan accomplished to the client s satisfaction, while communicating that the owner should consider this only a stopgap plan, and (iii) be ready when the business owner sees the light and comes back to you for the in-depth planning engagement that was needed all along. III. PREREQUISITES BEFORE BEGINNING IN-DEPTH PLANNING A. Understand the Client s Goals and Objectives A journey needs a destination; otherwise it s just a wandering through the wilderness. In the estate planning journey, the destination is the client s desire for where they want things to be after passing on. The description of the destination can be translated into definable estate planning goals and objectives, including the Big Three questions of Who gets what?, How and when do they get it?, and Who s in charge?, but can also include quantitative goals (minimizing death taxes) and qualitative/subjective goals (minimizing conflict). The estate plan is a road map of how to get to the destination from here, including how to minimize tolls in the form of death taxes and other costs. Although some clients are good about filling out an Estate Planning Goals and Objectives questionnaire, it may take a couple of meetings or calls to firm up what the client s goals, objectives, and priorities are. In the interest of saving time, this phase of establishing the client s goals, objectives, and priorities can be in parallel to the due diligence phase, rather than one having to follow the other. B. Due Diligence Review to Understand Limitations and Parameters At a minimum, the following items and documentation of background information should be reviewed in the Due Diligence phase:

4 32 ALI CLE Estate Planning Course Materials Journal February 2016 i. Structure of the business itself, including form of entity (corporation, general or limited partnership, LLC, or other), jurisdictions of formation and registration, and its tax status (Subchapter C corporation, Subchapter S corporation, partnership, proprietorship). ii. iii. iv. Existing allocation of ownership and voting control, including each class of equity and whether voting or non-voting. Second party requirements: the instruments that govern the business and relationships among owners, including the Articles of Incorporation, By-Laws, and Shareholder Agreements, or in the case of a partnership, the Partnership Agreement, or for an LLC, the Operating Agreement; along with Buy-Sell Agreements for any form of entity. Third party requirements: loan covenants, franchise agreement, distributorship or dealership agreements; major supplier agreements; professional regulations that limit ownership to licensed professionals. 1 v. Goals of the owner(s) as to whether to keep or sell the business, which may depend on succession planning; note that there are different considerations between owners who expect to sell the business (or their stake in it) in the short-term to mid-term, versus those who wish to pass it on to the next generation. vi. Existing plans for succession, including whether one or more successors have been identified and how much additional grooming and training those successors will require. vii. Recent valuations and appraisals, if any, for the company as a whole (enterprise value) or the individual shares or units. C. Collaboration with Client s Other Advisors as a Team It is generally the case that estate planners need to know their client s other key advisors, but this is especially true for business owner clients. Not only should you know who your client s other advisors are, you should get introduced to the key advisors, establish a rapport and communications, and obtain at least an informal understanding to work together for the mutual client s best interests. Otherwise, you may find your proposals questioned or even sabotaged by other advisors who either don t understand your proposal or find it threatening to their turf. Ideally your client will authorize at least an initial meeting among the key advisors (preferably without the client 1 For example, governing law may require that a professional corporation have only owners who are professionals with the applicable license, so that an ownership interest would have to be redeemed or sold when the professional owner died or retired.

5 Estate Planning for Family Business Owners 33 present) to assure understanding of the advisors different roles and responsibilities and those key issues that each advisor considers most important for the mutual client. IV. THE VOTING / NON-VOTING RECAPITALIZATION One of the author s favorite techniques for the business owner client is one that provides a modest benefit considered alone, but can greatly facilitate other techniques with far more benefit. This technique is a recapitalization of the company to have both voting and non-voting shares (or units; for simplicity, this discussion will refer to shares). The arrangement works best with the vast majority being non-voting. A. Purposes of Voting/Non-Voting Recapitalization It is fairly easy to reorganize and recapitalize the entity that holds the operating business (typically a corporation, partnership, or LLC) so that it has two classes of stock, voting and non-voting. This can be used even in Subchapter S corporations, as the voting and non-voting distinction is the only exception to the general rule that a Subchapter S corporation may have only one class of stock Allows the transferor to shift economic value and future appreciation outside of the taxable estate, while the transferor retains control. Contrast that with a transfer of voting shares, in which the transferor effectively retained voting control over the transferred shares; under those facts the shares would be includible in the transferor s estate under IRC 2036(b). 2. Because gifts will not necessarily change control, this should make it easier to avoid breaching third party restrictions on change of control (but not blanket restrictions on change of ownership). 3. When the business is transferred to the next generation, the voting shares could be reserved for (or at least allocated in favor of) those family members who are active in the operating business. B. Steps for a Voting/Non-Voting Recapitalization The steps involved to establish a voting/non-voting recapitalization include the following: 1. Amend By-Laws. If the By-Laws do not already authorize a separate class of non-voting stock, amend the By-Laws to authorize the separate class of non-voting shares. As an aside, in some cases there may be advantages to leaving the primary class of shares as single-vote voting shares, and establishing the new class of shares as super-voting shares, perhaps with Internal Revenue Code (herein IRC ) 1361(b)(1)(D) (herein IRC ).