Buy/Sell Alternatives - Alternative Strategies

Transcription

1 Who s going to own your business after you? Review of Buy/Sell/Keep Alternatives Structure, Valuation, and Funding ADAMS CO.

2 Business Succession Children Active None Active One Owner fair vs. equal buyout vs. marital deduction incentives for key people to stay exit strategies attract, retain, reward key employees loyal to owner, not the business Multiple Owners voting vs. non-voting fair vs. equal separate lines of business family & business buy/sell agreement coordinate with estate planning avoid potential 183.3% problem

3 Adams Co. exit strategies Buyer wants to pay $1.5M for assets. Seller wants $3M to create $200,000/year of income. recruit, retain, reward key employees employees are loyal to owner, not the business

4 Adams Co. If SELLER is a C-Corp. (or was a C- Corp. that elected S-Corp. within 10- years) INSIDE GAIN $3,000,000 TAX (40%) ( 1,200,000) OUTSIDE GAIN $1,800,000 TAX (20%) ( 360,000) 52% NET TO SELLER $1,440,000 48%

5 Exit Strategies Sale of Stock One level of capital gain for the seller (may be postponed or avoided through CRTs and/or ESOPs). No tax break for the buyer and buys liabilities, as well. (however, buyer can make an election under IRC 338(h)(10)) Sale of Assets Possibly two levels of capital gains for the seller if a C-Corp. (but, a portion of the goodwill can be deemed personal ) Buyer can write-off the purchase over time. Sale of Services Payment for past, present, or future services may be fully deductible to buyer

6 Benefit of being an OWNER-EMPLOYEE EMPLOYEE as an OWNER Every dollar allocated by the business on behalf of its owners is an after-tax expense and the value that is created is included in the owners taxable estate as an EMPLOYEE The same dollar allocated by the same business on behalf of the same person, but now as an employee is either tax deductible by the business or the value is excludible from the employee s taxable estate

7 Sale plus Deferred Comp. $3M Valuation, for example $2M Def. Comp. NET: $1M buy assets for the lowest reasonable defensible value and provide deferred compensation for the balance

8 VALUATION At what price would you SELL the business? $$$ $ Employee Benefits -- qualified or non-qualified What price would you pay to BUY the business from me?

9 Sell vs. Sell and Deferred Comp. Buyer saves $500,000 on $1,500,000 Buyer would need to start out with before tax dollars Tax: (40%) Net for Buyer SELL DEF.COMP. $2,500,000 $2,000,000 (1,000,000) $1,500,000 Seller s cost basis in the stock: Realized Gain Tax: (20% or 40%) Net to Seller ( 0) $1,500,000 (300,000) (800,000) $1,200,000 $1,200,000 EROSION DUE TO TAXES: 50.4% 52% 40%

10 Sell vs. Sell and Deferred Comp. Seller nets $300,000 more on $1,500,000 Buyer would need to start out with before tax dollars Tax: (40%) Net for Buyer SELL DEF.COMP. $2,500,000 $2,500,000 (1,000,000) $1,500,000 Seller s cost basis in the stock: Realized Gain Tax: (20% or 40%) Net to Seller ( 0) $1,500,000 (300,000) (1,000,000) $1,200,000 $1,500,000 EROSION DUE TO TAXES: 50.4% 52% 40%

11 Sell vs. Sell and Deferred Comp. Seller and Buyer each save $187,500 Buyer would need to start out with before tax dollars Tax: (40%) Net for Buyer SELL DEF.COMP. $2,500,000 $2,312,500 (1,000,000) $1,500,000 Seller s cost basis in the stock: Realized Gain Tax: (20% or 40%) Net to Seller ( 0) $1,500,000 (300,000) (925,000) $1,200,000 $1,387,500 EROSION DUE TO TAXES: 50.4% 52% 40%

12 Planning Alternatives Buyer wants to buy the assets for $1.5M, but Seller wants to sell for $3M to generate $200k/year of income. 1. Establish a non-qualified deferred comp. plan for Seller As the next slide compares, SELLER s pre-tax cost is $2,250,000 vs. $2,500,000 DECREASE: $250,000 BUYER receives $1,600,000 vs. $1,200,000 INCREASE: $400,000 business establishes a non-qualified benefit for the current owner prior to the sale, to lower the purchase price for the business, for example. 2. Then, if C-Corp., buy the assets for the inside basis

13 How can $3M = $1.5M? Year Compensation Deductible Deductible 40% 30% 1 $200,000 $120,000 $140,000 2 $200,000 $120,000 $140,000 3 $200,000 $120,000 $140,000 4 $200,000 $120,000 $140,000 5 $200,000 $120,000 $140,000 6 $200,000 $120,000 $140,000 7 $200,000 $120,000 $140,000 8 $200,000 $120,000 $140,000 9 $200,000 $120,000 $140, $200,000 $120,000 $140, $200,000 $120,000 $140, $200,000 $120,000 $140, $200,000 $120,000 $140, $200,000 $120,000 $140, $200,000 $120,000 $140,000 TOTAL $3,000,000 $1,800,000 $2,100,000 PV 4% ($2,223,677.49) ($1,334,206.49) ($1,556,574.24) 5% ($2,075,931.61) ($1,245,558.96) ($1,453,152.13) 6% ($1,942,449.80) ($1,165,469.88) ($1,359,714.86) 7% ($1,821,582.80) ($1,092,949.68) ($1,275,107.96) 8% ($1,711,895.74) ($1,027,137.44) ($1,198,327.02) 9% ($1,612,137.69) ($967,282.61) ($1,128,496.38) 10% ($1,521,215.90) ($912,729.54) ($1,064,851.13)

14 Sell the stock WITH or WITHOUT Qualified or Non-Qualified Plan Buyer would need to start out with before tax dollars Tax: (40%) Net for Buyer BEFORE AFTER $2,500,000 $1,250,000 (1,000,000) (500,000) $1,500,000 $ 750,000 Seller s cost basis in the stock: PLUS RETIREMENT: Realized Gain Tax: (20%) Net to Seller ( 0) ( 0) $1,500,000 $ 750,000 (300,000) (150,000) $1,200,000 $ 600,000 $ 0 $1,000,000 $1,200,000 $1,600,000

15 Herbert K. Daroff, J.D., CFP He is an attorney by education and a CERTIFIED FINANCIAL PLANNER TM practitioner by profession. Mutual Funds magazine (8/2001) recognized Herb as One of the Top Advisers in the Northeast; Worth magazine (7-8/2002) included him in The 250 Best Financial Advisers; and Medical Economics magazine (11/2004) listed him in The 150 Best Financial Advisers for Doctors. Herb s creativity, experience, and resourcefulness enable him to work well with clients and their personal advisors. HDaroff@baystatefinancialplanning.com

16 The contents of this presentation are intended for education purposes only. The presentation provides a brief summary based on our understanding and interpretation of current law. All tax references are to federal tax law only, unless otherwise stated. This presentation includes changes made by the 2001 Tax Act. All these changes are to expire at the end of Pursuant to IRS Circular 230: The information contained in this material is not intended to, and cannot be used to, avoid IRS penalties. This material supports the marketing and promotion of life insurance. Seek advice based on your particular circumstances from independent tax, legal, accounting, insurance, investment, and financial advisors. Individuals, including business owners, should not apply any of these concepts without coordinating with attorneys, accountants, life insurance agents, investment advisors, financial planners, etc. Consult with your professional tax advisor about your personal situation before making any decisions. This is not intended to provide tax or legal advice. Advisors should not apply any of these concepts to their clients without: (1) establishing a mutually agreed upon scope of their engagement; (2) gathering necessary and sufficient objective and subjective data given the client s goals, needs, and priorities; and (3) evaluating that data and determining alternative strategies consistent with the mutually agreed upon scope of the engagement and the data collected. Herbert K. Daroff, J.D., CFP is a Registered Investment Advisor in Massachusetts doing business as BAYSTATE FINANCIAL PLANNING.