What is a Will?

A will is a signed document that conforms to state law to provide for the distribution of the assets of a decedent upon his or her death. The distribution of assets is carried out by an executor–the person appointed in a will to manage and distribute the decedent’s estate. The process of distributing assets that pass under a will is overseen by the probate court in the county in which the decedent resided. The “probate” process involves varying degrees of cost and difficulty depending on the circumstances. In addition to providing for the distribution of assets, a will can also designate guardians of minor or incapacitated children of the decedent.

What is a Trust?

A trust is also a mechanism for managing the distribution of assets upon your death. However, unlike a will, a trust affords the ability to manage assets during your lifetime, as well as upon death. Trusts come in many different forms and they are employed to accomplish various needs, including maintaining the privacy of your estate, managing assets efficiently, maximizing the use of estate and gift tax exemptions, avoiding probate, and protecting your estate from creditors and unanticipated changes in family circumstances, like divorce.

When a living trust is employed, it is necessary to transfer substantially all of your assets into the trust during your lifetime. This, in turn, allows family members to avoid the cost and hassle of probate. The management and distribution of trust assets is carried out by a trustee, the person who holds legal title to the trust’s assets for the benefit of the trust’s beneficiaries. The initial trustee is often the original settlor, the person who created the trust, followed by a successor trustee upon the settlor’s death or incapacity. Any assets that are not transferred into a trust during the lifetime of the settlor can pass into the trust upon the settlor’s death through a “pour over” provision in the settlor’s will.

What is Right For You?

Every family’s needs and circumstances are unique, thus there is no one-size-fits-all estate plan. The costs and benefits of both a will and a trust should be carefully weighed in order to ensure that the assets you have worked so hard to amass are appropriately protected, that your family is provided for to the fullest extent possible, and that your wishes are properly carried out upon your death. If you have any questions about estate planning or would like help determining whether a will or trust is right for you, we would encourage you to call or schedule an appointment to visit with us.

Gifting assets to children or grandchildren can be a very effective method of minimizing, or even eliminating, estate taxes at the time of one’s death. This is because any assets that are properly gifted during one’s lifetime are excluded from his or her taxable estate at the time of death. Often, individuals will gift assets that have a relatively low value at the time of the gift, and yet are likely to experience appreciation and have a much higher value at the time of death. Life insurance policies, businesses, and real estate are all assets that often fall into this category.

Relief was provided to those wishing to make large gifts when President Obama signed a multi-billion dollar tax cut package into law last December. Under this new law, an individual can make lifetime gifts valued at up to $5 million without incurring any gift tax. This is quite remarkable considering that in the previous twenty years the maximum that individuals could gift on a tax-free basis ranged from only $600,000 to $1,000,000. For those individuals who are inclined to make large gifts to children or other family members, now is the time to consider doing so.

The opportunity for making large gifts on a tax-free basis may be short-lived. The Joint Select Committee on Deficit Reduction (commonly referred to as the “Super Committee”) is scheduled to announce its proposals for deficit reduction near the end of this month. There is concern among many that the Super Committee will recommend reducing the gift tax exemption from $5 million to $1 million. If so, and if this recommendation is passed into law, an extremely beneficial tax savings opportunity will no longer be available.

If you believe gifting of assets may be of benefit to you and your heirs, we would encourage you to call or schedule an appointment to visit with us.

In the traditional estate plan, a formula clause is employed to calculate an amount that will pass into a “credit shelter trust.” What goes into the credit shelter trust is property equal to the amount that can pass estate tax free at the first spouse’s passing. The credit shelter trust can be for the benefit of a surviving spouse, with the assets of the trust avoiding estate tax on the death of that spouse. However, sometimes clients with children by prior marriages determine that this “tax- free” amount should pass directly to children, or to trusts for their benefit, when the first spouse passes. When the estate tax exemption amount ranged from $600,000 to $2,000,000 or even $3,500,000, this method of determining the gift to children may have achieved the result desired. Yet when the exemption amount was raised to $5,000,000 this year, would that be best?

Also the expected return on investments for the surviving spouse might have been higher years ago than it is now. What effect would that have on the outcome from the funding formula in the will or trust?

Consider the case of a husband and wife who both have children from previous marriages. Their community property assets are $5,000,000 with an additional $4,000,000 in life insurance–$2,000,000 on each person. To avoid the children from the first spouse having to wait until their step-parent passes away to receive any inheritance, each of the spouses left their respective “estate tax free amount” to their own children, with the excess going to the surviving spouse. If the plan was executed in 2007, when the exemption was $2,000,000, the result would be the children receiving $2,000,000 and the remainder passing to the surviving spouse. Consequently, the surviving spouse ends up with $7,000,000 in assets and the children with $2,000,000. However, in 2011, when the estate tax exemption is $5,000,000, the formula causes this “tax free” amount to go to the children, with the surviving spouse receiving $4,000,000.

In addition, current investment returns on the assets left to the surviving spouse are the lowest they have been in decades. The spouse may have received the house or other non-income producing assets as a part of his or her inheritance. As a result, not only is the surviving spouse receiving less of an overall inheritance, but his or her ability to earn income with the inherited assets is impaired as well.

The question is whether this is an unintended consequence from a flexible formula clause that is stretched so far that it is now broken. Call us if we need to help determine if your documents accomplish what you desire.

For all the above reasons, it is imperative that the seller/business owner avoid trying to navigate uncharted waters without capable assistance. More specifically, it is critical for the seller/business owner to assemble a team of professionals who are intimately familiar with the planning and negotiations related to selling or merging a closely-held business. Just as not all physicians are adequately trained and sufficiently experienced to perform brain or open-heart surgery, not all CPAs or lawyers are trained and experienced to adequately assist clients before, during, and after the sale of a business. While the stakes of a business sale may not rise to the level of being considered “life or death”, they do stand to have a significant impact on the lifestyle of seller/business owner going forward, and the choices and opportunities available to him or her (and/or future generations). Because the effects of a business sale are typically long-lasting and far-reaching, and because these opportunities are so very rare, it is important that the selection of professionals who will be advising the seller/business owner throughout this process be taken very seriously.

Once the seller/business owner has selected the right experienced professional advisors, it is imperative that he or she consult with them as early in advance of the sale as possible in order to maximize the planning opportunities available to the seller. The seller/business owner should avoid at all cost the temptation to wait until after sale negotiations have started, a letter of intent has been signed, or draft agreements have been exchanged, before consulting his or her advisors. By that point in time, not only will the seller/business owner have likely failed to implement most, if not all, of the critical planning tips discussed in Parts I thru IV of this blog series, but will have likely also missed out on some powerful tax planning or negotiation opportunities that may be of significant benefit to the seller/business owner, future generations or perhaps even charities.

Contrary to conventional wisdom, the sale of a business is not just an event, but rather a process. This process starts years in advance of the actual closing, and requires continual interaction between the seller/business owner, CPA, attorney, and financial advisor. All are necessary to properly implement the preparatory steps we’ve discussed throughout this blog series.

We hope this blog series has proven to be informative and helpful. If we can be of further assistance to you or your business, please give us a call.

Many business-owners started their own business venture precisely because they wanted to be in an environment where they could control their professional and financial destiny. What’s more, many business-owners made the initial decision to venture-out on their own only after becoming frustrated with corporate organizations that were inexorably confined by corporate hierarchy and frustrating politics. Their desire to disassociate themselves from anything resembling their previous bureaucratic corporate culture, coupled with their need to keep overhead costs as low as possible, often leads to a business that lacks executive management beyond the founding owner. For those purchasers who will be relying heavily on the existing management team after the closing, this is a real cause for concern.

Most purchasers assume that the founding owner/seller will likely be far less motivated to assist the purchaser after the closing, especially in those instances where the seller receives all, or even a significant portion, of the purchase price at closing. Additionally, when the founding owner is the primary point of contact with the most critical customers of the seller’s business, the purchaser will often have concerns that such important relationships may be in jeopardy once the business is sold and the founding owner’s role in the business lessens. In both cases, the purchaser can’t help but begin to wonder whether the business really has any “goodwill” value that extends beyond the seller. When those thoughts begin to occur, the prospective purchaser may become concerned enough with the post-closing viability of the business that he or she elects to either pass on the transaction as a whole, or use it as justification for reducing the purchase price offered to the seller. In either case, the seller stands to lose.

To maximize the amount the seller expects to receive at closing, the seller must locate and train the right person(s) who can leverage the founding owner’s skills and relationships, and help demonstrate to the purchaser that the business has intrinsic goodwill value far beyond the founding owner. Of course, this does not happen overnight, and is something that the seller/business owner must begin to develop well in advance of a sale. At the same time, the founding owner must be careful that he or she is not training-up his or her new competition.

Our firm frequently advises our clients about how they can best manage the delicate balance of bringing on new management personnel without putting at risk the business they have worked so hard to build. To the extent we can assist you in addressing the legal issues related to building a management structure that will maximize the value of your business, please give us a call.

As most would expect, experienced buyers will want to gain a very detailed understanding of the seller’s corporate ownership structure by reviewing the entity’s organizational documents and other contractual agreements that are in place between the seller’s equity owners. In addition, buyers will want to review any agreements with key employees, customers, and suppliers, lease agreements for mission critical facilities and equipment, loan documents, intellectual property agreements, along with other important license, franchise, distribution, manufacturing, pricing, and other important arrangements that give the seller its competitive advantage in the market.

Having the above structure and relationships well-documented, vis-à-vis written agreements, gives the potential buyer confidence that he or she knows exactly (i) what is being purchased, and maybe just as important, (ii) the extent of the potential risks related to the acquisition. Few things shake a buyer’s confidence more (and reduces their willingness to pay more) than when a seller is unable to provide the potential buyer with key legal agreements that should form the very foundation of the seller’s business.

Putting yourself in the shoes of the buyer, consider the reluctance you might feel upon discovering that (i) the seller has no long-term written commitment from its most important raw materials supplier, (ii) that none of the seller’s senior executives have signed confidentiality/non-compete agreements, (iii) that the seller’s most important retail or manufacturing location is operating under a hold-over lease arrangement, (iv) that a critical portion of seller’s product offerings are utilizing third-party intellectual property without the benefit of a written license agreement, (v) that certain key personnel have been previously granted a “profits interest” in the seller’s business without any formal agreement outlining its terms, or (vi) that one (or more) of the seller’s equity owners has been granted a right of refusal related to any potential sale of the business but no agreement has been executed outlining the scope of this right. These are just a small sampling of the kinds of issues potential buyers can face when conducting due diligence; any one of which could derail the transaction in its entirety, or negatively impact the price the buyer may be willing to pay to the seller.

As a general proposition, buyers are not inclined to pay a premium for an operation that is disorganized, fails to attend to critical details, or is otherwise going to require an inordinate amount of work after closing in order to bring the business up to the buyer’s expectation level. We often assist our clients by examining what critical agreements need to be in place as a precursor to any sale transaction. The farther in advance of closing these types of agreements are implemented, the more benefit the seller derives, and the more comfortable the buyer will be that these agreements represent the seller’s standard operating procedure, and not merely last-minute window-dressing.

Call us if we can assist you.

Even well-prepared financials may not tell the whole story with respect to the business and its real profitability and potential earning capacity. How so? Consider that most seller/business owners wisely work very hard to minimize federal, state, and local taxes payable on an annual basis. There are a number of different ways in which seller/business owners might accomplish this objective. Maybe they gave themselves and/or their other family members extra fringe benefits. Maybe they hired their children and included them on the payroll. Maybe they took what would have otherwise been net profit and reinvested it back into certain extraordinary capital improvements related to the business. Maybe the seller/business owner also owns the land and building that the business occupies, and the owner has been receiving rent payments that may not be reflective of a more tenant-friendly market. Of course, the desired outcome in each of the above instances is to reduce the overall profitability of the business, by applying the profit-deflating strategies mentioned above. Were a prospective purchaser to review the owner’s financial statements for a business where one or more of those strategies have been implemented; the purchaser would not appreciate the true profitability of the business. Without a deeper explanation and understanding of the financial statements, the purchaser’s offer would almost certainly be artificially depressed.

What prospective purchasers frequently want to see is a projection of the cash flow potential of the business under their management. In order to do this, the seller and his financial advisors will need to “recast” the financial statements in a way that allows the purchaser to see the true profit potential of the business, without any of the tax planning strategies described above.

The purpose of recasting financial statements is not to mislead a potential purchaser. Rather, the objective is to give the potential purchaser a truer picture of the business he or she is looking to purchase, and to help him or her better understand the business’ profit-generating potential (free of any profit-deflating tax strategies). From the seller/business owner’s perspective, this process of recasting financials helps the seller better understand the true performance of his or her business, and increases the purchase price that the seller can ultimately justify in a sales transaction.

We often aid our clients by working with their other professionals to prepare businesses for sale in a way that would maximize the sale price to be experienced. Call us if we can help.

In this blog series, we will highlight five (5) things every small business owner should consider well in advance of any sale transaction. At the top of any business owner’s list of sales considerations must be the status of his or her internal financial reporting. A seasoned purchaser will typically ask to review the most recent three (and sometimes up to five) years worth of financial information regarding the seller’s business in advance of any transaction. The more formal your financial statements (CPA-audited statements are preferred by purchasers, however, CPA-reviewed or CPA-compiled statements may be sufficient), the better first impression you will make on the prospective purchaser. When a savvy purchaser reviews a business with poor, incomplete, or uncertified financial statements, the purchaser will likely make certain general assumptions about the business it is targeting.

In most cases, the prospective purchaser will be inclined to assume that the lack of good financial data means the seller’s internal operations are somewhat loose and inefficient. More times than not, purchasers are apt to believe that good financial reporting leads to tighter internal controls, and better in-depth operational analysis, which can then be used to implement best practices critical to increasing profitability. To the extent the seller’s financial reporting (or lack thereof) has left a negative impression, the amount of risk the purchaser may be willing to assume (e.g. the size of the purchase price he or she may willing to pay) is likely going to be negatively impacted.

Additionally, when a prospective purchaser comes across a seller with substandard and uncertified financial reporting, if they are not otherwise scared away altogether, the purchaser will invariably be forced to dedicate significant time and resources to independently verify the seller’s financial statements. This verification process is often very costly, and some purchasers will insist upon receiving a credit against the purchase price in order to recoup all (or some portion) of their costs related thereto. Moreover, this process can take significant time, which will inevitably delay the closing and the seller’s receipt of the sales proceeds, and is often times a serious interruption to the seller’s ongoing day-to-day business operations. In point of fact, the purchaser’s internal auditors and outside accountants will routinely require the seller and/or the seller’s key financial officers to help re-trace financial transactions for the years in question, which prove to be a considerable distraction to those critical members of your executive management team. On top of that, in many instances the prolonged presence of such strangers in the seller’s office often raises questions and suspicions among the seller’s own personnel. As the internal questions begin to surface, word often leaks-out that a sale of the business is being considered. At that point, the fertile minds of key employees, suppliers, and customers begin to wander, and the proverbial “horse is out of the barn” forever, which could strain key business relationships and/or compromise your negotiating leverage with the buyer.

The first step to a successful sale transaction is having accurate, thorough, and certified financial reporting that can be presented to any potential purchaser. In our second installment in this blog series, we’ll highlight the some of the more important portions of the financial statements that can help you increase the purchase price you receive.

One of the arguments in favor of portability was that it would eliminate the need for some of the more complex estate plans, particularly those that involved a “bypass” or “credit shelter” trust. However, this argument does not take into account some of the significant non-tax benefits that can be achieved by implementing these trusts as part of an estate plan. For example, assets held in a bypass/credit shelter trust will generally be protected from creditors and lawsuits. Additionally, the assets in a bypass/credit shelter trust will be protected from a divorce settlement if the surviving spouse dies and later remarries. Furthermore, for couples on their second or later marriage, the use of a bypass/credit shelter trust can be vital in making sure the wishes of the first spouse to-die are carried out after the surviving spouse passes away. None of these benefits can be achieved if one merely relies on the portability rules as the ultimate solution to his or her estate planning issues.

These issues are further complicated by the fact that a surviving spouse’s ability to use the estate tax exemption of a deceased spouse can be severely limited (or even permanently lost) if the surviving spouse remarries. Additionally, the portability rules, along with all of the other tax provisions included in the new law, are set to expire after 2012. For these and other reasons we have found that, in most cases, the same “tried and true” planning techniques that were used prior to the 2010 law changes have equal benefit today as well.

Please feel free to contact our office if you would like for us to review your estate plan in light of these new law changes.

1. Community property vs. separate property. Inheritances begin as separate property in the hands of a surviving child, but income from that property is community property and the property itself can be commingled over time and become community property. Cash investments, such as insurance proceeds, are easier still to commingle and more difficult to protect.

2. Exposure to creditors. Even if property is kept as separate property, it does not protect the assets against exposure from creditors. Liabilities come in all shapes and sizes, but include credit card debts, home mortgages, business debts, divorces and lawsuits of all types. One axiom in our society seems constant – if you have money, someone else thinks they deserve it more.

3. Little additional cost. A separate trust for each child might cost an additional $200 in an estate plan but could provide for the child to be their own trustee either initially or as they gain experience or maturity. There would be an additional cost to have an income tax return for the trust prepared annually, but the entire amount of the principal might be saved by doing so.

As a result, we almost always recommend the use of children’s trusts to receive inheritances and substantial gifts. If you have any questions about your estate plan, give us a call.