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1 SPRING 2014 for NEW HEALTHCARE FUNDING TAXES LIFE INSURANCE FOR SMALL BUSINESS FAMILY BUSINESS DYNAMICS PROFESSIONAL PRACTICES SUCCESSION PLANNING OF FINANCIAL SERVICES

2 WHAT S THE BEST STRATEGY FOR TURNING ASSETS INTO RETIREMENT INCOME? THE MOST PRACTICAL CREDENTIAL YOU LL EVER PURSUE. 3,000 advisors are already enrolled 3 relevant, video-driven courses In-depth knowledge from top experts nationwide Learn an effective retirement income planning process that will work in any economic environment. Transition from asset accumulation to wealth distribution Choose the right Social Security claiming age Mitigate plan risks effectively Explore solutions that work in low interest-rate environments Maximize government and private pension benefits Learn tax-efficient strategies Manage portfolios for retirement income planning BE KNOWN FOR YOUR EXPERTISE IN RETIREMENT INCOME PLANNING. Top Advisors Credentialed by: FinancialPlanningSuccess.com/RICP

3 ONLINE SPRING 2014 The Wealth Channel is your resource for peer-to-peer financial services insight and advice. New videos posted daily practice management, insurance, retirement planning, sales skills and more! WATCH NOW at TheWealthChannel.com Retirement Income Industry Update Kerry Pechter, editor of the Retirement Income Journal, takes a look at both the positive and negative trends in the retirement income industry. A Word With Woods David F. Woods, CLU, ChFC, LUTCF, former president of the LIFE Foundation, sounds off on news and issues affecting the life insurance industry right now. Social Media: Research for Producers A new study from the Northwestern Mutual Granum Center for Financial Security, Media Puff or Real Stuff?, provides social media insights for financial professionals. Life Insurance for Physicians Tony Corio of Devon Financial Partners explains how he helps clients within the medical market decide between term and whole life insurance. FEATURED EXPERTS FROM THIS ISSUE Wade D. Pfau, Ph.D., CFA, and professor of retirement at The American College, gives 10 reasons why advisors and their clients should reevaluate the 4 percent rule. Francis J. Lojewski, MSFS, ChFC, CLU, LUTCF, AEP explains why advisors need to help their pre-retirement clients prepare for tax changes sooner rather than later. Adam S. Beck, Esq., assistant professor of health insurance at The American College, gives advisors an update on the Obamacare small business exchange and provides advice for business owners still looking to provide health benefits for their employees. Lawrence L. Grypp, CLU, ChFC, and Michael A. Hirschfeld, Esq., offer best-practice advice for business owners and explain how advisors can help. Kenneth Polcari lets us know what s in store for the markets this year and talks savings, goals and concerns for the individual investor. Ted Kurlowicz, JD, LLM, CLU, ChFC, CAP, AEP breaks down the additional Medicare tax and the tax on net investment income, as well as the potential burden these place on business owners. GET CONNECTED The Wealth SPRING 2014 THE AMERICAN COLLEGE 1

4 CONTENTS SPRING 2014 The Wealth Channel Mobile App Get The Wealth Channel mobile app for free 50 Size Doesn t Matter The growing number of small businesses in the U.S. 56 Remembering O. Alfred Granum, CLU Honor a legend in our profession 82 UP FRONT 56 4 From the Editor 6 Chancellor s Viewpoint 8 Here s the Case 10 Ask Greg FINANCE 11 New Health Care Funding Taxes Ted Kurlowicz, JD, LLM, CLU, ChFC, CAP, AEP Tax burdens to help fund Obamacare are now in effect for business owners : First Half Market Outlook Kenneth Polcari What are investors greatest concerns for the 2014 market? INSURANCE 17 Uses of Life Insurance for Small Business Owners Richard C. Baier, JD, CLU, ChFC, AEP, CFP, CAP Life insurance is a strong tool that business owners should have in their arsenal. 20 Answering the Outrage David F. Woods, CLU, ChFC, LUTCF A solid life insurance program is essential to the American family s financial plans. 22 AG 38: A Need-to-Know Issue for Advisors David Szeremet, JD, CLU, ChFC and Pete Whipple, FSA AG 38 is not a niche issue of interest only to actuaries. 26 Disability Insurance More Than Cash Flow Protection Thomas R. Petersen, MBA, RHU Don t leave the success of your business or life s dream to fate. 28 A More Practical Way to Self-Insure Long-term Care Shawn Britt, CLU Self-insuring against long-term care risks might not be the best way to preserve a sizable estate. 30 Mitigate Medicaid Limitations for Special Needs Children Walter J. Rudecki, Jr. Safeguard a special needs child s future with public assistance and financial planning. 11 ESTATE PLANNING 33 Pick Your Business Partners or the State Will Pick Them for You! Kevin M. Lynch, CFP, CLU, ChFC, RHU, REBC, CAP, CASL, LUTCF, FSS Dictate how and where your business lands with a formalized agreement. 36 Professional Practices Need Focus on Succession Plans Richard L. Olewnik, JD, CLU, ChFC Taking steps now to ensure a professional business succession plan is in place can avoid major pitfalls later. RETIREMENT 43 Ten Reasons Why the 4 Percent Rule Is Too Simplistic Wade D. Pfau, Ph.D., CFA Help your clients plan for their retirement by considering the bigger picture. 46 Planning Retirement in a Rising Tax Environment Francis J. Lojewski, MSFS, ChFC, CLU, LUTCF, AEP Inflation, heath care costs and market volatility are just some of the challenges with which retirement planners must contend. DIALOGUE 51 Family Business Dynamics Stephen D. Tarr, MSM, CLU, ChFC, CASL, CAP Learn about the intricacies of communication within a family business. 2 THE WEALTH CHANNEL MAGAZINE SPRING 2014

5 EDUCATION 83 The American College Launches the NEW ChFC Christopher P. Woehrle, JD, LLM 85 Leadership Perspectives From a New MSM Graduate Tia Nichole McMillen, MSM PRACTICE MANAGEMENT 57 Small Business Owners Face Realization and Retirement Risks Peter Klein Recognize the risks and evaluate the options for a secure retirement. 61 Now, What Are You Going To Do With It? Gary A. May, CLU, ChFC Earning your financial services designation is just the beginning. 63 Build Value in Your Agency Eugene F. LoVasco, JD, CLU Do you subscribe to the value proposition business model? RESEARCH 67 Life Insurance Product Trends for the Ultra-Affluent Market Wayne Tonning Find out what s hot and what s not in life insurance for the wealthy. 73 The Dark Side of Index Fund Investing David Nanigian, Ph.D. Learn about the unintentional side effects of index fund investing on market efficiency, portfolio risk management, corporate governance and corporate financial policy. HEALTH 77 Future of Obamacare Small Business Exchange Looks Grim Adam S. Beck, Esq. Market realities pose big questions for the viability of Obamacare s Small Business Health Options Program. WHY WE DO WHAT WE DO 80 Inspiring Special Needs Daughter Illuminates Financial Advisor s Purpose Dennis M. Axman, CLU, ChFC, AEP, CFP The bravery of one special needs daughter inspired her dad to help others. 77 YOUR COLLEGE 87 Social Media s Secret Sauce and Other Recipes for Success Keith Hickerson, MSM 88 Frank Nathan, CLU Mary Anne Adler 90 The Granum Center Asks: Are You Playing to Win? 91 Big News on the RICP Front 92 Growing Your College s Leadership Team 93 Cary M. Maguire Center for Ethics in Financial Services Update 94 State Farm Women s Center Update 95 Educating Advisors in Retirement Income Planning: Expanding Our Video Library 96 The Granum Center Update 97 Hire a Veteran! 98 Welcome New Trustee Board Members 99 Linda S. Need Named Chair of Board of Trustees ALUMNI 101 Letter From the Alumni Advisory Board President 102 Knowledge Summit 104 President s Dinner 105 Recent Alumni of the Month 106 Alumni and Friends in Action 107 Alumni Calendar 108 Secrets to Longevity Erin Gazica ADVANCEMENT 109 Sternberg and Sievert Create Doctoral Fellowship 110 Peter Browne Proves One Person Can Make a Difference Allen Thomas, JD, CAP 111 One Person Campaign THE LAST WORD 112 Going, Going, Gone Reginald N. Rabjohns, CLU, ChFC 104 Visit thewealthchannel.com to view video segments from our featured experts or download the The Wealth Channel app and view them on your ipad or iphone. SPRING 2014 THE AMERICAN COLLEGE 3

6 FROM THE EDITOR OK So What? I RECENTLY READ ROBERT Powell s column in USA Today about how many people are embarrassed to seek help from a financial advisor. He quotes Ed Jacobson, a consultant from Madison, Wis., who said: It s virtually universal that people hesitate about sharing intimate information with others. All of us have fears, shame and embarrassment about various matters: Money and sex are two of the strongest sources of these charged emotions. When you meet with potential clients for the first time, whether or not they appear cool, calm and collected on the outside, there s a good chance they re battling financial advisor anxiety on the inside. They may fear that you will judge them negatively over their lack of financial footing. They may be embarrassed to discuss a subject they feel should be kept within the family. They may even feel shame over having a significant amount of wealth. So what should you do in the preliminary discussion to help individuals feel more comfortable? Offer them water, coffee or a soft drink? Ask about their family? It is going to take much more than that. Setting their minds at ease takes the right environment, strong relationship skills and the ability to ask a lot of open-ended questions. Here is one way your College can help. We are beginning our sixth year of publishing the Wealth Channel Magazine. Over the years, the magazine has covered numerous themes including diversity, longevity, family, financial health and change, to name just a few. We have published more than 1,000 pages of content. Our focus is on you and how you can utilize the information to better serve your clients, whether it is one-on-one in a fact-finding or sales situation or in a leadership role in the field or home office. If you are creating, servicing or maintaining operations in our profession, we want this publication to be meaningful to you in your area, too. To see just how well we are doing, we asked The College s assessment team to develop a survey of our readership. With a respectable 2.3 percent return on our sample, two findings were very clear, according to our Associate Vice President for Institutional Assessment Tom Armington, Ph.D. The magazine is effective in the contribution of specific articles to our readers professional growth and the usefulness of the information about recent or upcoming changes in the industry. We have to do our best to serve our clients by helping them understand they do not have to be ashamed, embarrassed or afraid. In this issue, we zero in on business owners. Check out Ted Kurlowicz s article, The Impact of New Health Care Funding Taxes on Business Owners and Professional Practices Need Focus on Succession Plans, by Richard Olewnik. Richard Baier talks about Uses of Life Insurance for Small Business Owners, and you will not want to miss Wade Pfau s article that explains Why the 4 Percent Rule is too Simplistic for Retirement Planning. In my interview for this issue, Larry Grypp and Michael Hirschfeld discuss their work with family businesses. Mike draws from over 37 years practicing law and dealing with hundreds of family and closely held businesses. Larry is the director of the Goering Center at the University of Cincinnati, where he manages the largest family business center of its kind in the country. And that is just the start. 4 THE WEALTH CHANNEL MAGAZINE SPRING 2014

7 Acting President and CEO Michael C. Davidson, MSM, CLU, CAP OK. So what? We have to do our best to serve our clients by helping them understand they do not have to be ashamed, embarrassed or afraid. We as advisors can help them with their hopes and dreams even though there will be setbacks and disappointment. I will never forget the day I went to deliver a death claim, and had to walk right past the widow and handed her brother-in-law a check for the life insurance proceeds. The beneficiaries of the life policies had been set up for the farm partnership buy-sell agreement but, unfortunately, the legal document for that buy-sell agreement was never executed. Therefore, the brother-in-law had no obligation to share any of the proceeds with the widow. The farm was not doing well at that point, so the money the brother-in-law received went to pay off debt and not to help the widow. It was a very eye-opening experience for me as a young manager. To this day I ask myself, What could I have done to make sure this orphan policyholder had been better taken care of? I was the one who was ashamed and embarrassed. We learn best from experience. We hope you find the shared experience, insights and information in this issue that concentrates on business owners helpful in your service to your clients, their families and their employees. Until next time If you would like to share your thoughts with Steve, feel free to him at Chancellor Laurence Barton, Ph.D., CAP Editor-in-Chief Stephen D. Tarr, MSM, CLU, ChFC, CASL, CAP Assistant to the Editor Mary Massaro Content Editor Marcia Ellett Proofreader Judy Keene Design Stephanie Ottavan Door No. 3 Design, Inc. Contributors Mary Anne Adler Denny Axman, CLU, ChFC, AEP, CFP Adam S. Beck, Esq. Richard C. Baier, JD, CLU, ChFC, AEP, CFP, CAP Shawn Britt, CLU Sandra Carr Jennifer DeTroye Ted Digges Erin Gazica Lawrence L. Grypp, CLU, ChFC Keith Hickerson, MSM Michael A. Hirschfeld, Esq. Sharen L. King, MSM Peter Klein Ted Kurlowicz, JD, LLM, CLU, ChFC, CAP, AEP David A. Littell, JD, ChFC, CFP Francis J. Lojewski, MSFS, ChFC, CLU, LUTCF, AEP Eugene F. LoVasco, JD, CLU Kevin M. Lynch, CFP, CLU, ChFC, RHU, REBC, CAP, CASL, LUTCF, FSS Gary A. May, CLU, ChFC Tia Nichole McMillen, MSM David Nanigian, Ph.D. Katy O Leary Richard L. Olewnik, JD, CLU, ChFC Thomas R. Petersen, MBA, RHU Wade D. Pfau, Ph.D., CFA Kenneth Polcari Gregory A. Purvis, JD, CLU, ChFC Reginald N. Rabjohns, CLU, ChFC Julie Anne Ragatz Walter J. Rudecki, Jr. David K. Smucker, MSM, CFP, CLU, ChFC David Szeremet, JD, CLU, ChFC Allen Thomas, JD, CAP Wayne Tonning Pete Whipple, FSA Christopher P. Woehrle, JD, LLM David F. Woods, CLU, ChFC, LUTCF

8 CHANCELLOR S VIEWPOINT CFP A Continuing Dialogue FINANCIAL ADVI- SORS LOOKING TO take their education and professionalism to the next level have more choices now than ever before. The two premiere designations are the Certified Financial Planner (CFP ) certification and the Chartered Financial Consultant (ChFC ) for advanced planners. Increasingly, planners are also seeking master s degrees in financial services or even doctoral-level education to advance their work. Because the CFP Board has been the subject of many headlines recently, you may be interested in some of the backstory. The CFP Board s certification requires a rigorous program of study; that s the main fact to consider. Your College is one of many institutions offering an approved educational program that qualifies a candidate to sit for the CFP Board examination. Students from The American College sitting for that program in 2013 had a pass rate that was percent higher than the average pass rate for all other providers. We take pride in delivering tangible advantages to students who pursue that education with us. Over the past decade, I have praised those who have achieved CFP certification because the focus on personal finance is exceptional. I have also shared concerns that the governing body, the CFP Board of Standards, has sought through a variety of lobbying and public affairs efforts to become a pseudoregulator for financial planners. Recently, the Board has suffered notable setbacks as it has struggled to define fee-only planners. It is in federal courts defending itself against important challenges from practitioners. It is working to reverse a sizeable decline over the years in those sitting for its examination. Every organization has its share of struggles, and the CFP Board has had a few rough years. Let me tell you why I still support the mark itself and the education it represents. A little context helps: The CFP Board is simply not equipped to serve as a regulator of financial planners. It encounters difficulties whenever it tries to move in that direction. One example is the issue of labeling planners as being fee-only. A Financial Planning magazine reporter recently called 20 of the almost 500 advisors with wire houses who had been inaccurately referring to their practice as fee-only and found that these professionals were largely not fee-only. This was months after a Wall Street Journal exposé revealed that the CFP Board website was not properly differentiating fee-only from commissioned advisors. Financial Planning noted: After the CFP Board altered the profiles in September, it instructed those 8,000 planners to rethink their compensation disclosure choices before selecting one of three options: fee-only, commission and fee, and commission-only. Later on, however, it quietly removed fee-only as an option for all wire house advisors without informing either the public or CFP holders. This is no small act by the CFP Board. It is a major recognition that its proper role is not one of regulator or overseer for planners. It excels when it focuses on building resources and community for planning professionals less so when enacting and enforcing a multitude of rules and regulations. No institution, including ours, is perfect but we also don t support creation of a self-regulatory organization (SRO) for planners who are already subject to state and federal oversight for the activities they perform. The lawsuit against the CFP Board I referenced earlier also highlights the same fee-only issue, which also resulted in high-level leadership resignations at the CFP Board. The core issue involved in the lawsuit is a planning firm that was sanctioned by the CFP Board for referring to its practice as fee-only when the planners have separate Registered Investment Advisor (RIA) and insurance enterprises. We have no data from the CFP Board on what it is spending 6 THE WEALTH CHANNEL MAGAZINE SPRING 2014

9 on defense for this suit, but if it moves to class action status, the profession will again suffer from perceptions of lack of monitoring, accuracy in defining what is fee-only and numerous sidebar questions. Again, any issue for the CFP Board comes from regulations built around the CFP certification mark, not from anything related to the quality of the mark itself or the advisors who hold it. The CFP Board s newest round of ads use the phrase highest standard rather than anything referring to the fiduciary or best interest language, primarily because of these fee-only issues. The American College has been using highest standard of knowledge and trust to describe ChFC for years, and it s a positioning that has grown our mark substantially over that time. In the end, we re all pulling in the same direction. More education and professionalism for advisors means a better-served consumer. Whether it s CFP, ChFC or an advanced master s or Ph.D. degree, the key is in deep knowledge ethically applied and continually enhanced with continuing education. So, in closing, at this interesting time in the history of professional education, maybe the most interesting comment about the CFP Board comes from one of its designation holders, as quoted in Financial Planning: I m absolutely oblivious to what s even on my profile, says Dale Christenson of UBS Financial Services in Omaha, Neb. I know it s a big deal to the CFP people. I m sure they take themselves very seriously, but my day isn t going to change whether they exist or whether they don t exist. I m glad I have [the CFP], I enjoy it but if I didn t have that designation, I d just get another one. Dale, I welcome your call at any time to talk about the 150,000+ graduates and designation holders of The American College. We have a compelling history regarding ethics, standards, superb education and credentials to share with you. Laurence Barton, Ph.D. CAP Chancellor The Wealth Channel Magazine Copyright The American College Board of Trustees All rights reserved. The Wealth Channel Magazine ISSN (print) The Wealth Channel Magazine ISSN (online) This publication is a service to the alumni and friends of The American College, and is intended for a professional audience. The content of this magazine may not be copied or reproduced without the written consent of The American College. The Wealth Channel Magazine and the content therein are not legal or tax advice. Always consult an attorney or tax advisor. The opinions expressed in this publication reflect the views of the author and not The American College, The American College Alumni Association, the editors, publishers or any other party. The American College and this publication s editors are not responsible for any errors or omissions printed in this publication. The marks CLU, ChFC, CASL, CLF, CAP, REBC and RHU are the property of The American College and may only be used by individuals who have successfully completed the initial and ongoing certification requirements for these designations. Certified Financial Planner Board of Standards Inc. owns the certification marks CFP, CERTIFIED FINAN- CIAL PLANNER and CFP (with flame logo) in the U.S., which it awards to individuals who successfully complete CFP Board s initial and ongoing certification requirements. If you would like to share your thoughts with Dr. Barton, feel free to him at SPRING 2014 THE AMERICAN COLLEGE 7

10 HERE S THE CASE GETTING THE FAMILY BUSINESS READY TO SELL CASE STUDY DAVID K. SMUCKER, MSM, CFP, CLU, ChFC David has been in advanced consulting and sales with Nationwide for 24 years, working in executive benefits as well as business and estate planning. Prior to that, he was an IRS auditor for seven years and a practicing CPA for 15 years. He frequently writes for professional journals. Consider the following case study, which represents nobody in particular and is meant only to illustrate a point. Provide your own response to this case. David at THE SCENARIO Owners of family businesses have a tendency to retain profits within the business, using them to expand. They see the business as an expression of themselves; they want to see it grow and prosper. In the process, the business can become 80 to 90 percent of their estates, and they often neglect saving much for retirement. Therefore, at retirement they face two problems: How can they keep the business in the family? How do they fund their retirement? The following case study, based on a family farm, illustrates the problem and presents a possible solution. Bob and Donna Jackson own a farm in the Midwestern United States. It is mostly a row crop operation, but they also have a hog feeder system. They have three children, Tom, Dick and Harriett. All three are happily married with families. Tom helps Bob with the row crop operation and wants to take it over someday. Dick s interest is in the hog operation; he currently runs it and would like to take it over someday. Tom and Dick are both on Bob s payroll. Harriett is a physics professor at a West Coast university. She enjoyed growing up on the farm but is not interested in running or owning any part of it. Bob and Donna want all three children to be treated equally, but they also want to be sure Tom gets the farming operation and Dick gets the hog operation. They also want to keep things together so they can pass the estate to the next generation intact. The details on Bob and Donna s estate are as follows: Row crop operation $6,000,000 Hog operation $2,000,000 Other assets $ 400,000 Total $8,400,000 Much of Bob and Donna s estate is land 800 acres valued at $8,000 per acre. The hog operation takes up 100 acres, while the row crop farming takes up the remaining 700 acres. In addition, the row crop operation rents and farms another 2,000 acres. Fortunately, based on the 2012 exemption of $5,000,000 per person and inflation adjustments, a federal estate tax liability is unlikely. However, given the composition of their estate, it will be difficult to treat all three children equally 8 THE WEALTH CHANNEL MAGAZINE SPRING 2014

11 and still get the operations where they need to go. And there s still the question about how Bob and Donna will generate a retirement income. SOLUTIONS As to dividing the estate, they could simply leave an undivided onethird of each estate asset to each child. That would force Dick and Harriett to become Tom s partners and Tom and Harriett to be Dick s partners. Harriett and Dick could gang up on Tom to change the direction of the row crop operation and possibly even force the sale of the farm. Tom and Harriett could gang up on Dick to the same end. That solution certainly would be equal and just as certainly not equitable, and it would be rife with potential conflicts. Something is needed to equalize the bequests, but what will it be? The solution might be in an option to buy, funded with $3,200,000 of joint and survivor life insurance on Bob and Donna, owned by Tom. For example, assuming that Bob passes away first, Donna s will could leave the row crop equipment and some of the land (total value $2,800,000) to Tom in a specific bequest and grant him an option to buy the rest of the row crop land for $3,200,000. Tom would have funded that option with the $3,200,000 from the joint and survivor life insurance on Bob and Donna, assuring him of the funds to exercise the option at Donna s death. Tom would exercise the option, buying the remainder of the row crop land, thereby acquiring 100 percent of the row crop land and equipment. Having $3,200,000 cash in hand, the estate would then have the resources to: Distribute the $2,000,000 of the hog operation s land, equipment and livestock to Dick, along with $800,000 cash Distribute the $400,000 of other property to Harriett, along with $2,400,000 cash The net result: The three children receive equal treatment, Tom and Dick keep the operations they wanted and the estate is passed on intact all three children are not only treated equally but equitably. An added benefit is that the land will get a stepped up basis as it goes through Donna s estate, and it will work the same as if Bob were the last to pass away. What we have not dealt with is Bob and Donna s retirement income. Fortunately, the answer is simple: They become landlords. Let Tom and Dick take over the row crop and hog operations and become the owners of those operations, probably forming limited liability companies (LLCs) to house them. To generate their retirement income, Bob and Donna can charge Tom and Dick rent for the land and whatever else (e.g. buildings, trucks, tractors and other equipment) they use. Tom and Dick can start buying their own equipment as Bob s existing equipment wears out or becomes obsolete. Bob could even give them the obsolescent pieces of equipment (perhaps using his annual gift tax exclusion) to use as trade-ins for new equipment purchased by Tom and Dick s separate operations. Finally, until retirement Bob can work for Tom and Dick and be on their respective payrolls. All in all, this would make for a smooth, relatively inexpensive transition. SPRING 2014 THE AMERICAN COLLEGE 9

12 ASK GREG Please explain why the EOLI rules are important for my client. The employer-owned life insurance (EOLI) rules are contained in IRC Section 101(j), which limits the amount of death benefits under an employer-owned life insurance contract that will be excluded from an applicable policyholder s gross income, to the sum of the premiums and other amounts paid by the applicable policyholder with respect to the contract. Death benefits above this limit are included in the applicable policyholder s gross income as ordinary income unless one of the specific exceptions applies. In other words, the death benefit is not income tax free, but taxable (with an offset for premiums paid). The Code has changed the default for employer-owned insurance to taxable unless the taxpayer takes action. Section 101(j) applies to life insurance contracts issued after August 17, An employer-owned life insurance contract is defined as a life insurance contract that: 1) is owned by a person engaged in a trade or business and under which such person (or a related person) is directly or indirectly a beneficiary; and 2) covers the life of an individual who is an employee with respect to the trade or business of the applicable policyholder on the date the contract is issued. The EOLI rules include two significant exceptions to the general taxability of insurance proceeds of EOLI policies. One exception protects the tax-exempt status of death benefits where the insured was an employee within 12 months of death or a highly compensated employee or highly compensated individual (as defined in the statute). The other exception protects the tax-exempt status of death benefits that are paid to a family member, trust or estate of the insured employee, or that are used to buy an equity interest in the applicable policyholder from a family member, trust or estate. These two exceptions apply only if, before the contract is issued, the employee is notified in writing that the applicable policyholder intends to insure the employee s life and the maximum face amount for which the employee could be insured, and that an applicable policyholder will be the beneficiary of the death benefits. The employee must also consent in writing to being insured on such terms and that such coverage may continue after the insured s employment terminates. The stakes are high: taxable death proceeds vs. tax-free death proceeds if the procedures aren t followed. Client discontent and possibly an errors and omissions claim against the producer will result if the rules aren t closely followed. And there is basically no method to correct an error previously made, as the taxpayer client must file an annual income tax return attachment to notify the IRS of the EOLI. Interestingly, the IRS just recently released PLR , which Gregory A. Purvis, was the Service s first attempt JD, CLU, ChFC is to apply the EOLI rules to the assistant vice president of advanced sales and conventional buy-sell agreement market development at OneAmerica. He is also situation. The taxpayer in the ruling a member of AALU, was a closely held corporation the Society of Financial Service Professionals, whose shareholders were also the Planned Giving employees. The corporation and the Group of Indiana and NAIFA. shareholders executed a buy-sell agreement to facilitate continuity in the management of the corporation by providing for the purchase of each shareholder s stock at death or termination of employment. The agreement required the corporation to buy and maintain insurance policies on the life of each shareholder, and to be the owner and beneficiary of all of the policies. If the agreement was terminated or a shareholder disposed of his or her interest in the corporation in a manner permitted under the buy-sell agreement, the shareholder was given the right to buy the policies on his or her life from the corporation. Policies that were not bought by the corporation remained its property to be retained or disposed of as it wished. Each shareholder had to complete an insurance application for the corporation to buy the policy on his or her life stating that the corporation would be the owner and beneficiary of the policy and the amount of coverage being obtained. Before the shareholders received their policy applications, the corporation provided them no other notice of its intent to buy the policies, the amount of coverage or the fact that the coverage could continue even after the shareholder ceased to be an employee. Such separate documentation was provided after the corporation bought the policies. The question, then, was whether the corporation had met the requirements for notice and consent. The IRS was quite pragmatic in its approach. It looked at the total of all the documents involved in the transaction and found that each shareholder was actually notified by signing both the policy application and the buy-sell agreement. The better practice is to prepare a separate notice and consent document for each applicant before the policy is issued. First, other taxpayers can t rely on this ruling as precedent; and second, the taxpayer paid a lot of money to obtain this favorable ruling. Carefully follow the above EOLI rules to stay away from mistakes that could cost you and your client. HAVE 10 THE A QUESTION WEALTH CHANNEL you MAGAZINE think would SPRING be 2014 good for Greg to share with readers? Ask Greg at

13 FINANCE 2014: First Half Market Outlook / 15 / New Health Care Funding Taxes The Impact on Business Owners By Ted Kurlowicz, JD, LLM, CLU, ChFC, CAP, AEP Tax burdens to help fund Obamacare are now in effect for business owners. Ted Kurlowicz is professor of Estate Planning and a professor of taxation at The American College. wcinput.com THE FEDERAL INCOME TAX treatment of business income for both the business and its owner is a complex topic. Tax minimization, of course, is an extremely important goal when selecting the form of business entity and determining the type of operations. This article is not a comprehensive discussion of income taxes but focuses on the impact on business owners of two SPRING 2014 THE AMERICAN COLLEGE 11

14 FINANCE new tax provisions provided by the Affordable Care Act of 2010 (ACA). With limited exceptions, only a C corporation is a separate taxpayer. In this instance, the business s net income is taxable at corporate rates and does not have an immediate impact on the corporation s shareholders. In the case of a closely held corporation, many or all of the shareholders will also be treated as statutory employees. For proprietorships, partnerships (including LLCs) and S corporations (greater than 2-percent shareholders), the owners of the business will be treated as self-employed. All income of such pass-through entities is taxed directly to the owners. Two tax burdens were enacted to partially fund the ACA and took effect beginning with 2013 income. The 2013 tax preparation will be the first time business owners will see the burden of these taxes. additional medicare tax The first ACA funding provision affects earned income from self-employment and wages for statutory employees. An additional.9 percent Medicare tax was imposed on earned income for higher earners. No additional tax is imposed on the employer. Essentially, this makes the Medicare tax 3.8 percent for earned income over the threshold, without a ceiling on earnings. For stockholder-employees of a regular corporation, this would apply to wages above a threshold amount (provided in the table). For owners of pass-through entities, this would apply to self-employment income over the threshold amount. Because the threshold amounts are not indexed for inflation, more and more taxpayers will be affected as time goes on. The business has a compliance burden to withhold the tax for earnings above $200,000. The business only considers the employee s income and not that of his or her spouse. Adjustments for over- or under-withholding would be made on the individual tax return. THRESHOLD EARNING AMOUNTS FOR THE NEW AFFORDABLE CARE ACT PROVISIONS Married filing jointly Modified Adjusted Gross Income (MAGI) over $250,000 Single taxpayer MAGI over $200,000 Married filing separately MAGI over $125,000 tax on net investment income The ACA imposes a 3.8 percent tax (Medicare contribution tax) on net investment income (NII) for taxpayers above the threshold amounts, which are identical to the thresholds for the.9 percent additional Medicare tax. The key to understanding the impact of this tax on business owners is the definition of items included (or excluded) from the definition of NII. For this purpose, NII includes: Interest Dividends Annuities Royalties Rents (Note: exception for self-rented property discussed later) Gains (Note: exception for gains on property held in a trade or business that is not a passive activity) Items that are excluded from the definition of NII include: Trade or business income Income treated as self-employment income Sale of a partnership, LLC or S corporation by an active participant Distributions from IRAs and qualified plans Build-up amounts in life insurance and deferred annuities Income tax exempt under the Internal Revenue Code Charitable trusts 12 THE WEALTH CHANNEL MAGAZINE SPRING 2014

15 Business owners are going to become painfully aware of these taxes when returns are filed this April 15. The 3.8 percent tax applies to the lesser of the NII or the taxpayer s MAGI in excess of the applicable threshold amount, for example: A shareholder-employee of a closely held corporation (filing status: single) had $400,000 in wages, $150,000 in dividend income and MAGI of $550,000 in The taxpayer would be liable for $1,800 in additional Medicare tax on his or her wages ($400,000 wages - $200,000 threshold amount, multiplied by.9 percent) and $5,700 on unearned income ($150,000 NII multiplied by 3.8 percent), for total additional taxes of $7,500. There are many tax implications for a variety of business owners. owners of a closely held corporation Because the closely held corporation is a separate taxpayer and shareholders who provide services can be treated as statutory employees, the tax treatment is fairly straightforward. Reasonable salaries are deductible by the corporation and create wage income for the employee. This income will be included in MAGI and subject to the additional.9 percent Medicare tax once the shareholder-employee is above the threshold. Dividends distributed to shareholders are NII and subject to the 3.8 percent tax for affected taxpayers. Gains from the sale of stock will be included in NII. owners of pass-through entities For sole proprietors, partners, members of an LLC or S corporation shareholders, income that is treated as self-employment income is subject to the.9 percent additional Medicare tax but not the tax on NII, once the taxpayer reaches the MAGI threshold. There is a small caveat here: Some income items of the business, such as rental income, interest and gains or losses, might not meet the definition of self-employment income and will be treated as NII. Hence, income or gains on working capital of a pass-through could expose the pass-through owners to the tax on NII. For an S corporation and perhaps an LLC, not all income is necessarily treated as self-employment income. Certainly, wages to the shareholder-employee of an S corporation will be self-employment income. However, it is also possible to shift income to passive investors of the S corporation, and such income is a dividend or NII. SPRING 2014 THE AMERICAN COLLEGE 13

16 FINANCE Sales of an interest in a pass-through should avoid the definition of NII if the seller was an active participant in the business. An exclusion from NII is provided by the statute and regulations for net gains on the sale of the interest as if the property were sold by the partnership, LLC or S corporation. The new taxes enacted to partially fund the ACA are little known and much more complex than they first appear. self-rental activity This article intentionally does not address the complex rules in the regulations concerning the potential treatment of a real estate investor to avoid the passive activity rules. However, the regulations address the issue of self-rental of real estate and provide an important exception for such rental income from NII. This is important because it is fairly typical for the owner of a closely held business entity to lease one or more buildings (owned personally or in a controlled entity) to his or her closely held business or professional practice. Rental income in such instances avoids the definition of NII if the taxpayer leases the building to a business in which the landlord materially participates. For example: Tom operates his law practice in an S corporation. He personally owns a building that is leased to the S corporation. The net rental for the lease avoids the 3.8 percent Medicare contribution tax. real estate professionals The treatment of rental income as NII is one of the more complex areas in this law. The final regulations address this and had to re-address the regulations under the passive activity rules, which have not been examined since the 1980s. Rental income will be exempt from treatment as NII if the taxpayer is either a real estate professional (who participates more than 500 hours in the activity or has participated in more than 500 hours in the activity for five of the last 10 years) or rental income is derived from an active trade or business (as described in IRC section 162). The final regulations are also quite flexible with respect to individuals who have multiple real estate activities. If the taxpayer has pieces of real estate and meets the active participation test with respect to some but not others, the activities can be grouped together, and the taxpayer will be treated as meeting the material participation requirement with respect to all real estate activities in the group. Beginning in 2014, a one-time regrouping of activities can occur in the first taxable year that the taxpayer would be subject to tax on NII. selected strategies for avoiding the tax on nii Many possibilities exist for mitigating the impact of the 3.8 percent tax on NII. Each business owner s position is unique and strategies will involve complex planning and implementation, such as the following: Rebalance portfolios to favor investment in assets that do not produce NII, such as municipal bonds, rental real estate (that meets the real estate professional definition), permanent life insurance and deferred annuities. Maximize contributions to qualified retirement plans and IRAs. Give consideration to a Roth IRA conversion. Make gifts of business interests to family members: Shift income to junior generation family members and reduce the senior generation s MAGI. Shift passive income to family members under the income threshold. Make or increase charitable contributions to reduce the business owner s MAGI and shift NII to a nontaxable charity. The new taxes enacted to partially fund the ACA are little known and much more complex than they first appear. Audiences in professional groups have seemed somewhat shocked when I ve presented my analysis of these taxes. Business owners are going to become painfully aware of these taxes when returns are filed this April 15. Hopefully, this article provides a quick introduction to the implications for planning to mitigate these taxes. 14 THE WEALTH CHANNEL MAGAZINE SPRING 2014

17 FINANCE 2014: First Half Market Outlook By Kenneth Polcari What are investors greatest concerns for the 2014 market? WELCOME TO AFTER 2013, many are wondering what is in store for the markets and for the investor as we move from all the handholding to allowing the markets to possibly stand on their own merits. Investors have some decisions to make about what they are saving for, their financial goals and concerns, etc. Then they must create their plan, eliminate the noise and concentrate on the future. After last year s impressive return for the S&P, many wonder, Can I expect that again? Kenneth Polcari is director of NYSE Floor Operations for O Neil Securities, Inc. He is also a regularly featured market commentator on CNBC s Power Lunch with Sue Herera and Tyler Mathisen and Taking Stock with Pimm Fox, among others. wcinput.com Much of what I say and discuss is about getting individual investors back into the market, restoring their confidence and understanding of the market and the role it plays in the longer-term plan. Don t bank on it. And should you be paying attention to all of the prognostications? Maybe, but remember, trust your instincts. In January 2013, the consensus for the market was a relatively modest view though most predicted a positive year, none predicted an outstanding year. If you had listened to most, you would have expected a 5 percent to 7 percent return for stocks, which is the norm really, but was not the case in By year-end 2013, the market delivered a whopping 30 percent return clearly one for the record books, but one that investors should not expect again in Much of what I say and discuss is about getting individual investors back into the market, restoring their confidence and understanding of the market and the role it plays in the longer-term plan. Many small business owners are first and foremost concerned about their businesses as they should be. But after they have settled in and can concentrate on providing for the future, a balanced, diverse portfolio should be part of that plan and a good financial advisor is worth his weight in gold. Many are concerned that the market s 30 percent increase in 2013 means that it can t go up further in Not so, but the market will have its challenges, at least in the first half of the year. We have a new Fed Chair, Janet Yellen, the debt ceiling debate and we had a mixed earnings season, which has left many to wonder when earnings will improve due to top line revenue growth versus cost cuts and buybacks. And we had the market test technical levels, both on the upside at 1850 SPRING 2014 THE AMERICAN COLLEGE 15

18 FINANCE and the downside at Herein lies the dilemma: How do investors begin? Where do they begin? One must create the plan, outline the goals and then stick to them. Analysts predict the beginning of a return to normalcy, though many question, What is normal? With rates so artificially low and continued mixed macro and micro data, it can be confusing and frustrating. So here is where the plan becomes helpful. Expectations for 2014 include: A solid 3 percent gross domestic product (GDP) growth Steadily declining unemployment rate Reduction of Fed stimulus An improving European economy Stabilization in Asia Normalization of U.S. interest rates If all of this comes together, then a return to normal does not feel so farfetched. But do not expect it to be a straight line so much can happen. Since the beginning of the year the market has churned, not making a move higher or lower as it tries to assess what the future looks like. We entered the earnings season with high hopes, and we saw many companies beat the expectation while others continue to struggle. Top line revenues continue to be a challenge for so many. Earnings continue to beat lowered expectations as companies cut costs and initiate stock buybacks. They are not yet growing top line revenues, and this is the challenge. Investors expect (and rightly so) that companies will start producing real top line revenues that produce real earnings growth, allowing for larger profits that will flow to dividends, capital spending, buybacks and possibly more acquisitions. Among all of this bullish talk, many call for a correction. Some are so bold as to call for a 20+ percent correction. That I do not see, but one must prepare for an eventual correction of some sort. The question is will it be 5 percent, 10 percent, 20 percent? No matter what it is and I think no more than an 8 percent to 10 percent correction going into the spring it will clearly take some of the fluff out of equity prices and allow the market to reprice based on developing macro data points. If the data continues to struggle, expect a swifter correction, but if the data shows stabilization, investors and markets will be forgiving and any correction will be met with natural buying interest. The months ahead will be full of Fed discussion. Will the taper stay status quo for a bit, or will they try to increase the taper with each month? If so, do investors support this move? What will happen to bonds and long-term rates at the height of the spring selling season? If the Fed loses control of rates, then expect housing to come under some pressure exactly what they do not want to happen in an election year. This market commentary is the opinion of the author and is based on decades of industry and market experience; however no guarantee is made or implied with respect to these opinions. This commentary is not nor is it intended to be relied upon as authoritative or taken in substitution for the exercise of judgment. The comments noted herein should not be construed as an offer to sell or the solicitation of an offer to buy or sell any financial product, or an official statement or endorsement of O Neil Securities, Incorporated or its affiliates. 16 THE WEALTH CHANNEL MAGAZINE SPRING 2014

19 INSURANCE Answering the Outrage / 20 / AG 38 / 22 / DI More Than Cash Flow Protection / 26 / A More Practical Way to Self-Insure Long-term Care / 28 / Mitigate Medicaid Limitations for Special Needs Children / 30 / Uses of Life Insurance for Small Business Owners By Richard C. Baier, JD, CLU, ChFC, AEP, CFP, CAP Life insurance is a strong tool that business owners should have in their arsenal. EVERY BUSINESS OWNER HAS problems to solve. What most business owners do not realize, however, is that cash value life insurance can be one of their better problem-solving tools. Life insurance can be a cost-efficient way to help accumulate capital, reduce expenses, retain key employees, fund a buy-sell agreement or nonqualified supplemental executive retirement plan Richard C. Baier is corporate vice president in case development with The Nautilus Group, a service of New York Life. Richard is an attorney with more than 37 years of financial, estate, business, charitable and benefits planning experience. wcinput.com SPRING 2014 THE AMERICAN COLLEGE 17

20 INSURANCE and compensate the business for unexpected financial loss. Business life insurance can be owned by the business, or the business can sponsor, or pay for, a policy owned by a business owner, employee, director, contractor or trust for their benefit. Following are some common uses of life insurance by a business owner or business. Company-owned life insurance (COLI) can be used to: Reduce or eliminate financial loss due to death of a key employee, contractor or owner Retain key employees by providing executive benefits in the form of deferred compensation or death benefits Provide business continuation funding for an entity redemption Diversify the company s investment portfolio as an asset that does not correlate with market-based assets Provide security for a loan Secure a construction bond or other regulatory cash or bond requirement Company-sponsored life insurance is often used to provide: Group term life insurance Personal life insurance death benefits for key employees or owners Retirement benefits for key employees or owners Cross-purchase funding for a buy-out agreement between the owners Split dollar life insurance arrangements Following are some common problems that business owners can solve in whole or part with company-owned and company-sponsored life insurance. financial loss due to death of key person Businesses often insure their buildings and equipment against catastrophic financial loss. Why, then, do they not also insure their key people? Of course many do, but perhaps not enough. In computing the cost of a key person s departure, the basic variables to consider are the individual s contribution to profits and the time required to locate and train an equivalent replacement. Key person life insurance is used to fill the void left by the loss of an indispensable member of the organization. It can help: Provide funds to establish a replacement Replace lost profits Provide cash to pay off company loans Pay a tax-deductible death benefit to the key person s family Ensure ability of customers, creditors and employees of the business to carry on capital accumulation and balance sheet strength Certain businesses need to keep a strong balance sheet to satisfy security requirements of creditors, customers and regulatory agencies. Some businesses purchase a surety bond for this purpose. However, many use cash value life insurance with its easy access to cash values as a means to accumulate working capital and strengthen the balance sheet, while simultaneously providing a death benefit that can be used for such purposes as key person insurance or employee death benefits. key employee retention Key employees can be incentivized to stay with an employer in a variety of ways: salary, bonuses, stock options, enhanced job responsibilities, work recognition and nonqualified executive benefits. Of these methods, life insurance has the greatest application to nonqualified executive benefits, including nonqualified deferred compensation and executive bonus life insurance. Nonqualified deferred compensation: A nonqualified deferred compensation plan that provides supplemental retirement income for key employees can be informally funded with employer or employee dollars, or both. Any such plan would need to meet the requirements of IRC 409A to avoid immediate taxation to the employee when funds are deferred by the employee or the employer s unsecured promise to pay the benefit vests. Deferral plan: Under an employee-funded deferral plan, the employee would elect to defer salary or bonuses in the year prior to when the deferral is made. The informal funding medium would typically be a permanent life insurance policy owned by the company. The employee would not have to pay income taxes currently on the amount deferred, but would pay income taxes when future benefit payments are received. The company would not take a deduction for compensation expense until the future benefit payments are made. 18 THE WEALTH CHANNEL MAGAZINE SPRING 2014

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