James M. Duggan, M.B.A., J.D. Tame the B.E.A.S.T. James M. Duggan, M.B.A., J.D. DUGGAN BERTSCH, LLC 303 West Madison, Suite 1000 Chicago, Illinois 60606-3321 e-mail: jduggan@dugganbertsch.com website: www.dugganbertsch.com (312) 263-8600
JAMES M. DUGGAN, M.B.A., J.D. James M. Duggan is a principal of DUGGAN BERTSCH, LLC, a Chicago-based business, tax, estate and wealth planning firm comprised of attorneys and accountants. Jim s practice has concentrated principally on business and corporate law, and estate and wealth planning, primarily as they relate to closely held business interests and high net worth families. Jim s experience in the structuring and implementation of Family Offices, sophisticated tax planning, and asset protection planning strategies is nationally recognized, as is his role in the firm s development of a leading multidisciplinary planning protocol. In addition to giving frequent lectures and authoring articles in his areas of concentration, Jim also serves as a director on numerous for-profit and not-for-profit organizations. Jim s educational background includes attaining a Bachelor of Science in Marketing from the College of Commerce and Business Administration at the University of Illinois at Urbana-Champaign (Magna Cum Laude), a Masters in Business Administration in Finance from the DePaul University Graduate School of Business (Summa Cum Laude), and a Juris Doctor from the DePaul University College of Law, where he was awarded positions on both the DePaul Law Review and DePaul Business Law Journal.
B.e.a.s.t. Buy-Sell Planning
Reasons For a Buy-Sell Agreement A BSA is critical for the private company, above all, to provide certainty, but also: a) To restrict transfers b) To create Permitted Transferees c) To clarify desired trigger events for purchase d) To provide a guaranteed market for ownership interests e) To establish purchase price or valuation method f) To establish payment terms g) To avoid litigation h) To assist with tax planning i) And, did I mention, to create certainty
BSA and Purchase Structures The BSA can be structured as one of the following: a) Redemption Company redeems interests from owners b) Cross-Purchase owners purchase interests from each other c) A combination of the two
Tax Implications of Redemption Structure $ ( Redemption ) Outgoing Shareholder Remaining Shareholders Future Sale of Interests $ 3 rd Party Transfer of Interest NO STEP-UP IN BASIS X% 0% Y% 100% Company Capital Gain to Outgoing Shareholder After redemption, Remaining Shareholders have 100% of Company Since Company Purchased, no increase in basis for Remaining Shareholders Upon subsequent sale, Remaining Shareholders have capital gains on sale price minus original basis (usually nominal)
Tax Implications of Cross-Purchase Structure Outgoing Shareholder ( Cross-Purchase ) $ Transfer of Interests Remaining Shareholders $ Future Sale of Interests 3 rd Party STEP-UP IN BASIS X% 0% Company Y% 100% Capital Gain to Outgoing Shareholder After purchase, Remaining Shareholders have 100% of Company Since purchased directly, Remaining Shareholders get step-up in basis equal to purchase price Upon subsequent sale, Remaining Shareholders have lower capital gains since gain is based on sales price minus increased basis
The Combination Structure The BSA can be structured to have the best of both worlds: a) First option to Remaining Shareholders b) Second option to Company (can also be mandatory)
Typical BSA Trigger Events Most owners are driven to enter into a BSA in consideration of one s death, but a more comprehensive list of desirable trigger events is: Death Disability Voluntary Transfer Involuntary Transfer Retirement Early Resignation Attainment of certain investment return Divorce Bankruptcy Loss of professional license Termination Dispute Passage of time Criminal conviction
Valuation Methods in the BSA Valuation methods include: a) Agreed Value adjust annually in minutes b) Agreed Formula industry norm or customized c) Appraised Value by one or more appraisers d) Amount of Insurance Proceeds death or disability e) A combination of the above * Consider punitive value in bad departure divorce * Consider full value or premium in good departure retirement * Greater of and lesser of standards can also be used
b.e.a.s.t. Estate Planning
The Core Plan Other Documents LIVING WILL Life Support Declaration * Individually titled assets are poured into Trust POUR-OVER WILL Pours All Assets into Living Trust * Probate Core Documents: Created @ Death: HEALTH CARE P.O.A. Agent for Health Decisions if incapacitated PROPERTY P.O.A. Agent for Financial Decisions if incapacitated LIMITED P.O.A. FOR BUSINESS DECISIONS Agent for Specific Business Decisions if incapacitated Asset not included in the Probate Estate. Remainder MARITAL TRUST (Marital Deduction) @ Spouse's death REVOCABLE LIVING TRUST A/B Planning @ Client s death * PRIVACY! * Estate Tax Minimization 1 st Lifetime Exclusion Amount less Lifetime Gifts. FAMILY TRUST (Lifetime Exclusion) BYPASS TRUST 2 nd Lifetime Exclusion Amount less Lifetime Gifts and Remainder after GST Gifts, if any. ESTATE PLANNING ADJUNCT LETTER GST EXEMPTION TRUST (Applicable GST Amt) NONEXEMPT DESC. TRUST (Balance) GST TAX TRUSTS
Probate What It Is and How to Avoid It Probate is a court proceeding to administer your estate and distribute your probate assets (e.g., individually owned assets in excess of state limit). Pros: - Court supervision/ oversight of administration - Statutory bar on claims after set period (6 months in IL) Cons: - Delay Generally takes a minimum of one year to complete - Costs Additional attorney and court costs - Lack of Privacy Wills must be filed with the Clerk, proceedings are open to the public - Will Contest
Last Will and Testament Provides for customized disposition of your probate assets: Outright Testamentary Trust created in the Will, or Pour-Over to Living Trust. Designate Executors and Guardians for minor children. If you don t provide for disposition of your assets, the state will! Beware the laws of intestacy
Revocable Living Trust Structure Agent *Settlor *Trustee *Beneficiary Agent s Revocable Living Trust *Avoid Probate (Privacy) Real Estate Agent s Business Portfolio
Property Power of Attorney Statutory form that allows you to designate agents to make financial decisions on your behalf while you are incapacitated. Authorizes your agent to handle assets that are not in trust. You can restrict or expand the agent s power. May also be nonstatutory (customized)
Limited Power of Attorney for Business Decisions Allows you to designate an agent to manage certain business matters specified by you. Allows for separation of personal and business financial matters. You can designate an agent that is more adept at handling sophisticated business matters. Important, and overlooked, Power of Attorney for private business owners.
Health Care Power of Attorney Statutory form that allows you to designate agents to make medical decisions on your behalf while you are incapacitated. You can also express your wishes regarding: Organ donation Disposition of Remains Degree of Life Sustaining Treatment May also be nonstatutory (customized)
Living Will Declaration Document that declares your wishes regarding life sustaining treatment if you have an incurable or irreversible injury, disease, or illness that is a terminal condition. States in part: I direct that such procedures which would only prolong the dying process be withheld or withdrawn, and that I be permitted to die naturally with only the administration of medication, sustenance, or the performance of any medical procedure deemed necessary by my attending physician to provide me with comfort care. May also require the opposite that such procedures be administered.
b.e.a.s.t. Asset Protection
Asset Protection Planning Comprehensive asset protection planning requires planning in two distinct areas: Business Protection Personal Protection
Limited Liability Business Structures Asset Protection in the business arena is generally accomplished through conventional entity planning: Corporations S or C Limited Partnerships with corporate GP Limited Liability Companies multi-member, single-member, series Limited Liability Partnerships professional and nonprofessional NO SOLE PROPRIETORSHIPS! * and may be enhanced through insurance.
Comprehensive Asset Protection Planning Aside from acting in a manner that will avoid lawsuits, and carrying sufficient insurance, personal asset protection optimization has two principal components: 1) Maximizing Exempt Assets 2) Transferring Non-Exempt Assets to Asset Protection Vehicles
Comprehensive Asset Protection Planning Step #1: Identify Exempt Assets in Your State and Maximize Those Assets Homestead Exemption Tenancy by the Entirety Qualified/Retirement Plans Nonqualified Retirement Plans Insurance Annuities Etc.
Step #2: Comprehensive Asset Protection Planning Transfer Remaining Assets to Asset Protection Vehicles: Business Entities Family LPs, LLCs, or LLPs Asset Protection Trusts Third Party, Self- Settled, Domestic, Offshore Other People but subject to trust and claims of their creditors
Planning with FLLCs Creditor Suit Real Estate Private Investments Business Interests Public Investments PPLI Insurance (1) Statutory Protection Protects Members from Claims Against LLC Assets Manager Family Limited Liability Company Members Preferred Jurisdictions: U.S. AK, NV, AZ, DE Int l Nevis, Anguilla, Cook Islands (2) Charging Order Protections LLC Assets from Claims Against Members * CREDITOR HAS A REMEDY, BUT IT IS A BAD ONE Parents Creditor Children Step into Economic Shoes Pay Tax on Phantom Income? Rev. Rul. 77-137 Statutory assignee Settlement is Advisable
Domestic APTs Permit Self-Settled Spendthrift Trust Available in 15 states and counting Concerns: Full Faith and Credit, Conflict of Laws Trustee Person/Entity Fiduciary Duties to Beneficiaries Power to Invoke Flight Provisions Power to Disregard Court-Ordered Removal Asset Protection Trusts Transfer Assets Irrevocable Trust Self-Settled Spendthrift Trust Avoid Probate Can be structured Inside or Outside of Estate Client/ Family Domestic/ Beneficiaries International Asset Protection Trust Creditor International APTs Permit Self-Settlement Don t recognize U.S. judgments Don t recognize U.S. lawyers Don t allow contingency fees Require significant bond Loser pays victor s fees Trustee has flight provisions More lenient fraudulent conveyance laws (1-2 years) Trust Protector Higher standard burden of proof Protector * CREDITOR HAS NO REMEDY! Power to Remove Trustee Power to Invoke Flight Provisions Power to Add/Remove Beneficiaries
b.e.a.s.t. Succession Planning
Company Succession Planning Corporate Contingency Plan Successor Directors stated in annual minutes Shareholder s Agreement
Personal Succession Planning Transition Plan for next generation/spouse Wealth Succession Plan LLC vs. Virtual Family Office Family governance and management designation Change in investment profile
b.e.a.s.t. Tax Minimization (Estate & Income)
Planning for the Taxable Estate When confronted with a taxable estate, an individual generally has 3 options in planning for the corresponding estate taxes: Pay them with own assets or with insurance Reduce them gifting, freezing, discounting Avoid them diverting income and acquisitions, and using charitable deductions
Pay the Estate Tax The Irrevocable Life Insurance Trust If paying the estate taxes with one s own assets is not desirable or possible, an Irrevocable Life Insurance Trust ( ILIT ) can be used to help facilitate the payment of such estate taxes by providing liquidity at the time of death. Properly structured, the ILIT is outside of the Decedent s Estate. An ILIT can also be used to create an estate. Client Insured Life Insurance Owner & Beneficiary (Collects Proceeds at Death) $ Gifting of Annual Premium Payments Remainder (Estate) Irrevocable Life Insurance Trust (ILIT) Estate Taxes Beneficiaries $ IRS Children
Reduce the Estate Tax Through Direct Gifting Estate taxes are reduced, not surprisingly, by reducing the size of the estate. Simple gifting strategies include: Formalized Gifting Programs (using the annual and/or lifetime exclusions) Qualified Tuition Expenses Qualified Medical Expenses 529 College Saving Plans (5-year front-loading = $65,000 tax-free) UGMAs/UTMAs Crummey Trusts/2503(c) Gift Trusts
Reduce the Estate Tax with Discount Planning Public Investments Private Investments Real Estate Personal Property Life Insurance Business Interests Transfer of assets into LLC at DISCOUNTED value (Discount #1) Parents Manager Family Limited Liability Company Parents Members Children/ Grandchildren Discounts Lack of Marketability Minority Interest DISCOUNTED Gifts of Membership Interests (Discount #2)
Reduce the Estate Tax through Freeze Techniques Freezing Asset Values with GRATs and IDGTs Family LLC Manager(s) (Transfer value, retain control) Client/ Spouse Annual Income Interest Discounted Gift or Sale of Ownership Interests Lack of Marketability Minority Interest GRAT/IDGT Children Grantor Retained Annuity Trust or Intentionally Defective Grantor Trust Serve as freeze techniques Further Leveraging of Discounts Maximize Annual and Lifetime Exclusions Additional Asset Protection
Avoid the Estate Tax by Diverting Acquisition Opportunities Perhaps the best way to avoid inclusion of an asset in one s estate is to never actually own the asset. Diverting original acquisition opportunities of business interests, real estate, competitive enterprises, and speculative securities to the next generation in the first place will remove the asset and all future appreciation from the estate.
Income Tax Minimization Four Basic Strategies to Reduce Income Taxes: Make Less Money? Increase Deductions Business, Personal Shift Income to Lower Tax Brackets Establish a Tax-Free Earnings Environment Municipal Bonds, Insurance, Annuities
Maximizing Business Deductions Through operating companies or family office structure, reduce income by the following means: Maximize Your Section 162 Business Deductions undergo a 162 audit with accountant Maximize Benefit Planning Deductions e.g., defined benefit/contribution plan Allocate Income/Compensation to Family Members in Lower Tax Brackets (e.g. pay for college, convert to Roth, etc.) Consider implementing a captive insurance company
Maximizing Personal Deductions Charitable Planning Charitable Remainder Trusts, Family Foundations, etc. Income Offset with IDCs e.g. investing in oil and natural gas Income Offset with NOLs e.g. investing in agribusiness
Shifting Income to Lower Tax Brackets Avoiding receipt of income altogether by shifting to children and grandchildren is an effective way to reduce taxes: Earned Income W-2 Passive Income K-1 (beware of the kiddie tax ) Diversion of Income Opportunities W-2 or K-1)
Establish a Tax-Free Earnings Environment Invest in Tax-Exempt Bonds may sacrifice performance Invest through Tax-Exempt Vehicles e.g., Insurance, Annuities Operate Business Through a Tax-Exempt Vehicle e.g., S Corporation ESOP, self-directed IRA
Establish a Tax-Free Earnings Environment Investing through Private Placement Insurance and Annuities Client *Asset Protection APT/LLC *Tax-free Investment Environment Variable Universal Life Insurance/Annuity *Advisable as long as costs outweigh anticipated taxes on earnings *Must be properly diversified under 817(h) Portfolio
Sample Captive Insurance Planning Structure Taxation of Premiums: 831(b) - $1,200,000 is tax-exempt Additional premium income can be offset by allocation to reserves Insurance Coverages Domestic Operating Company(ies) Deductible Premiums * FAIR MARKET VALUE TRANSACTION Reinsurance Pool (if necessary) Lower Cost Reinsurance of Likely Risks International Captive Insurance Co. Self-Insure Remote Risks Remainder of Premiums Insurance Reserves/ Surplus Exit/Access: Dividends, redemption or sale of stock taxed at LTCG if elect 953(d) status Loans (for real estate) Direct investment Deductions Asset Protection Trust/LLC Client/ Family Wealth Transfer: Includes children and grandchildren as owners to accomplish tax deductible estate transfers
Conclusion B E A S T - Have a buy-sell agreement. - Create an estate plan with a living trust to avoid probate. - Include a limited power of attorney for business decisions. - Protect your business assets with an LLC. - Protect your non-exempt personal assets with an LLC or APT(s). - Prepare a contingency plan for the business, and include successors in minutes. - Prepare a wealth transition plan using trusts or an LLC. - Consider discounted gifting of business or of a family LLC. - Shift income to lower tax brackets divert income opportunities. - Maximize use of tax-advantaged investment vehicles (ERISA, PPLI, captives, etc.).