ALI-ABA Course of Study Estate Planning for the Family Business Owner. July 11-13, 2007 San Francisco, California

Transcription

1 237 ALI-ABA Course of Study Estate Planning for the Family Business Owner Cosponsored by the ABA Section of Real Property, Probate and Trust Law and the ABA Section of Taxation July 11-13, 2007 San Francisco, California Practical and Creative Uses of Life Insurance in the Closely Held Business By Charles L. Ratner Ernst & Young LLP Cleveland, Ohio The views expressed herein are those of the author and do not necessarily reflect the views of Ernst & Young LLP. This document should not be construed as legal, tax, accounting or any other professional advice or service. No one should act upon the information contained herein without appropriate professional advice after a thorough examination of the facts of a particular situation.

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3 239 I. Overview of Presentation A. The Planning Process B. Planning for the Goluckis C. Life Insurance-Initial Planning Considerations D. Overview of Life Insurance Products E. A Brief Introduction to Life Insurance Due Care F. Working with the Agents G. Strategies for Paying the Premiums H. Insured Buy-Sell Agreements I. Designing an Executive Life Insurance Plan J. Case Wrap-up II. The Planning Process III. A. Goals and Objectives 1. What they want, when they want it, and how they want it to happen a. Practical b. Quantified c. Time bounded 2. But what if they can t always get what they want? 3. Fears and constraints a. What are they not willing to do to achieve their objectives? 4. A suggested order for your probing questions a. Personal financial objectives and concerns b. Lifetime and testamentary disposition of business and personal assets c. Tax minimization, liquidity for taxes, etc. d. Other interests (e.g., philanthropy) B. Present Situation 1. The facts, figures, and circumstances relevant to the Goals and Objectives 2. Ability to separate the wheat from the chaff is evidence of our experience and credibility 3. We must be able to tell them what we look for in each segment of the plan 4. Run applicable exhibits and analyses, but try to avoid paralysis by analysis C. Observations 1. How does the present situation align with the Goals and Objectives? 2. You told us what you want 3. We see where you are and what you are doing 4. We are now in a position to tell you that D. Recommendations 1. What we believe they should do to bridge the gap between the Present Situation and the Goals and Objectives 2. Recommendations can be tactical or strategic 3. Every planning dollar should serve more than one objective Planning for the Goluckis

4 240 A. Goals, Objectives and Constraints (With Some Foreshadowing by the Presenter) 1. What is this all about, really? a. In a word, Money! i. Retirement income ii. Health benefits iii. Survivor income iv. Perceptual issues in equalization b. How well will their planners listen in the usual rush to do estate planning? 2. Assure security for Happy a. What is the definition of security? b. Who gets to write the definition? c. Questioning the usual prescription before it s written i. Does Happy need a trust or just an investment advisor? ii. Would a well-informed Happy want her money in a trust? d. How well will their planners listen? 3. Transition ownership and management of Nevada to Martha and Steve a. When? b. How quickly? c. On what terms? 4. Treat Harry, Jr. equally with his siblings, but keep him out of the business a. What is the definition of equally? b. Who gets to write the definition? c. Any thoughts as to when equally should be determined? d. Any thoughts as to when Harry, Jr. should get his? 5. Provide adequate liquidity for federal and state death taxes a. They ll need a lot less liquidity if they transfer the business to Martha and Steve sooner rather than later b. Are they willing to pay current day gift or income tax to save future estate tax? Only kidding, of course, but we have to ask. 6. Retain key executives a. Retain them with stock, its reasonable equivalent or just plain money? 7. Do something for Duke University. a. Such as? b. How about one of those gifts that keeps on giving back? 8. Don t forget the Constraints a. Harry and Happy will be ready to make large gifts of cash or marketable securities just as soon as they can accurately predict the future. b. The family situation is a shipwreck, a situation that will make planning more difficult. B. Present Situation (in Impertinent Part) 1. Nevada is a C corporation with fairly rapid growth but dramatic variations in earnings over the past five years. a. Does this tell us something about appropriate selection and design of a strategy for transferring the business to Martha and Steve? 2. Harry owns the patent to the putter, which could be a perfect provider of 2

5 241 purchasing power post-retirement. 3. The new retail golf equipment store could present an opportunity for opportunity shifting to Martha and Steve at a low gift tax value. 4. Harry owns the business real estate, which is another source of cash flow for retirement. It is also an income-producing asset that can be fractionalized for gifts to an ILIT to pay premiums on the insurance Harry will need. 5. Nevada is the owner and beneficiary of $1,500,000 of life insurance on Harry. a. Is the policy really needed by the company? b. If not, let s start thinking about ways to get the policy out of the company? 6. We have the snapshot of their financial assets. Has anyone done a cash flow projection to see if Harry and Happy can afford to do wealth transfer planning? 7 We know what their estate plan does and does not do and will offer comments in the next segment (Observations). 8. There is a stock purchase agreement with the two executives. Is this the key employee retention plan? C. Observations 1. Harry does not have a financial exit strategy for a phase-out on his terms. a. All things considered, we really don t know how Harry and Happy s financial situation will coalesce for retirement. b. He is not maximizing use of the business effectively to build his personal net worth, so he is more reliant on the business for cash flow and less willing and able to plan. 2. Happy is probably not very well protected with enough sources of income independent of the business. 3. Equalization for Harry, Jr. will be difficult to accomplish at best. 4. Nevada s C corporation status might be a hindrance to wealth transfer. 5. Transfer taxes and expenses will not be minimized, thereby exacerbating the liquidity and equalization issues. 6. The corporate-owned insurance policy on Harry is probably in the wrong place. Though it could potentially be used for an IRC 303 redemption, it might be more effectively used by an ILIT for Happy s benefit or by Martha and Steve as partial funding for a buyout of shares from Harry s estate. 7. Their estate plan is not up to date and does not reflect their Goals and Objectives. a. It s too simple for effective planning, though it might be doing precisely what they want it to do. We need to delve further. b. Do they really want that brokerage account going to the children if Happy predeceases Harry? Given the facts and concerns as we know them, is it appropriate for Happy to bypass Harry entirely with these funds? 8. A transfer of the business to the children will begin to solve one set of problems while opening up a whole new set of (potentially more difficult) problems. Therefore, beyond their own testamentary planning, Harry and Happy will have to work with their advisors to design trusts, buy-sell 3