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Sweat Equity, Without The Equity

The business world abounds with stories of the entrepreneurs who managed success building an undercapitalized venture largely because they made little or nothing in the early years, choosing rather to channel revenues back into the growth of the business.
 
But there are often unsung heroes in these stories of delayed gratification: those talented and enterprising key employees who, captured by the vision and its opportunities, also sacrificed, giving up other more “sensible” opportunities, committing to onerous work schedules, and settling for less salary during their “salad days” so they might share in the bounty down the road.

The difference is that they have no ownership interest; and therein lies the sales opportunity.

Business owners with a conscience will be sure to reward such sacrifice among loyal employees when company fortunes turn.
 
Unfortunately there are some things over which the they have no control, like their unexpected premature death, or the level of obligation that successor owners might feel for those employees who played a role in getting the company to the dance.
 
There is an easy and economical way business owners can protect loyal employees, and the concept should be a club in the bag of every agent working the small to mid-sized business market, or who wants to be a player there.
 
Contact us to discusses how you can increase business sales using the concept of “loyal employee insurance.”
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Buy-Sell Planning While Generation Straddling

Two of the top ten reasons that younger women say that they marry older men are, first, they have a better read on those with a more promising future, even if it is shorter; and second, if they sprain their ankle they can use their husband’s cane.
 
Pretty funny, but not unlike a couple of the underlying reasons it might make sense for a young entrepreneur to associate with an older colleague in a business venture.
 
The “kid” has the track record of the potential partner to serve as a good indicator how much the codger will bring to the table in the time remaining in his or her active work life. And the older businessperson has picked up things along the way that may come in handy to overcome unexpected hurdles (the cane, just in case you aren’t following the analogy).

But a disparity in age always seems to create a fly in the ointment when it comes time to do some business transition planning.

When insurance ledgers are run in anticipation of insuring for a buy-out in the event of death there is often sticker shock over the difference in cost between coverage for the young ‘un and the old fogie.
 
Clients expect some spread in cost due to age, but not that much – and it doesn’t help that the older proposed insured’s medical history isn’t as positive as it used to be (after all, you generally don’t use a cane because there has been an improvement in health).
 
If properly addressed this bump in the road shouldn’t be a problem. Assume a case where the partners will buy each other out with policies they own on each other on which each will pay the premium.
 
Consider:
 
  • Because the need for coverage is a measurable period of time that is less than life expectancy, term insurance can be used to considerably lower cost up front. And it is usually eligible for conversion if the policy is needed longer for any reason.
  • The higher premium burden of the younger partner can be neutralized by double-bonusing the cost of coverage to both. This equalizes the expense by creating a zero after-tax outlay and the business is now seen bearing the overall cost of the transition plan.
  • After that, focus on the benefits each is to derive from the agreement: either a) the assurance that their heirs will receive a fair price in the form of cash for the business interest, or b) the assurance of funds to buy out a deceased partner and future full ownership of the business. What each partner derives from the buy-sell is exactly the same, exactly what they want, and exactly what they need.
An uninsurable partner creates different problems, but policy cost due to mere differences in age or insurable health should not be an objection.
 
Two other reasons in younger women’s top ten are that an older husband will introduce them to a whole previous generation of chick flicks (Thelma and Louise, Steel Magnolias and Breakfast at Tiffany’s), and he can help with homework.
 
Contact us with any and all questions that come up in buy-sell planning for clients of any age.
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Executive Bonus With Cost Recovery!

Okay, let’s start with a few premises and see where it leads: Love is blind/ Marriage is an institution/ Love and marriage go together/ Therefore, marriage is an institution for the blind.
 
I don’t know if Aristotle would approve of the structure of that syllogism, but it does illustrate that when you put two things together you can sometimes get surprising results, for better or for worse.
 
Take, for example, the three most common non-qualified benefit scenarios that usually involve life insurance: deferred compensation, split dollar, and executive bonus.
 
For simplicity and ease, an employer will usually choose an executive bonus arrangement, i.e. the executive buys insurance, the employer pays for it and reports the amount each year as taxable compensation.

The problem is, the employer often wants recovery of all or part of the plan cost if the executive cuts and runs early.

It takes a little more work and costs a little bit more, but this can be accomplished by putting two things together, for the better in this case. Try treating a split dollar plan like an executive bonus arrangement that turns over control of money paid to the executive only according to the terms of an agreed upon “vesting-like” schedule.
 
Here’s how it works:
 
Employer-paid premiums in the executive-owned policy are treated as loans. Each year the executive must recognize as income only deemed interest on the loan, usually to the tune of the AFR rates. This is an additional tax cost incurred by the executive. But current rates are so low the amount is usually not significant. Besides, if the employer chooses, the extra tax cost can be “zero-ed out” with a bonus. The employer’s rights to recover company cash from the policy if the executive goes are secured by a collateral assignment.
 
As time goes on, and according to the terms of the agreement, the loan is forgiven in increments. The amount of each reduction in the loan is reported as income to the exec and deductible to the employer – the same as an executive bonus plan.
 
As the loan drops, so does the amount of imputed interest recognized by the executive. Once the loan is reduced to zero the collateral assignment is released and we are back to a plain old vanilla executive bonus arrangement.
 
Sound logical? How about this: Some philosophers have three vowels in their name/ Socrates has three vowels in his name/ Therefore, Socrates is some philosopher. If you don’t really care then try this: All human beings are different/ All apathetic people are indifferent/ Therefore, no apathetic person is a human being.
 
Call with your next executive benefit case and we’ll show your client how they can assure recovery of funds if the participant leaves, without a whole lotta fuss.
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Business Transition Planning: How To Survive The Buy-Sell Agreement

This article speaks to a ready market. Why? Because statistics suggest that 80% of all small and mid-sized businesses in the country have made no adequate plans for transition in the event of one owner’s retirement, long-term disability, or premature death. And “adequate” includes being properly reduced to writing. All the understandings and oral agreements in the world are not worth the paper they should have been written on. Tell every transition-planning resistant client that they go to bed every night not knowing who will be their business partner when they wake up!
 
In addition, and perhaps most critically, there are no arrangements regarding the rights of a co-owner if another owner decides to sell out to a third party. Again, ask every transition-planning resistant client you have how they would like to get out of bed only to find they are in bed with their competitor.

But the focus here is only about one planning concern when purchasing life insurance to fund the agreed-upon buyout of a deceased owner: avoiding an unmanageable multiplicity of policies.

It usually makes sense to structure the buy-out outside the company through a “cross-purchase” agreement among the owners.
 
This assures that the full purchase price will be reflected in the increase in basis of the surviving owners.
 
In a cross-purchase each owner must own a piece of the insurance on all the other owners to buy a proportionate share should any other die first. If there are only two owners it’s a cake-walk. Each has a policy on the other. But things get exponentially burdensome as the number of parties increase. Three owners would require 6 polices, 4 owners need 12, and on it goes.
 
If the business is a partnership or an LLC taxed as a partnership there is an easier way.
 
Simply purchase one policy on every owner and have each held by the non-insured owners jointly-with-right-of-survivorship. On the death of one of the joint policy owners the rights to the death benefit are automatically reapportioned among the survivors. And since they are “partners” the reallocation of interests in the policy does not raise transfer-for-value issues.
 
But all must understand that anytime personally owned policies are used to fund a buy-sell agreement things only go smoothly when everyone fulfills their obligations – i.e. the estate sells the interest of the deceased owner and the survivors use the death proceeds to make the purchase from the estate, all under the terms of the agreement.
 
If the parties to a buy-sell are uncomfortable with personal ownership or the business structure doesn’t lend itself to protection from possible transfers-for-value (C-Corp, S-Corp, or an LLC taxed as a C-Corp or an S-Corp) then the policies are commonly held in an LLC or a partnership created for that purpose.
 
Contact me with any questions that arise in your casework involving business transition planning, and ask for our simple 4-page summary of business planning issues including the considerations that should be addressed in a well-constructed buy-sell agreement – either call at 706-614-3796 or email at tom@cpsadvancedmarkets.com.
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Term Insurance: Examining The Conversion Options

By the end of the story the pigs have begun to walk upright and they carry whips. Promised improvement in conditions for other citizens have been forgotten. And the Seven Commandments that were to serve as the foundation for the common democracy have been reduced to just one: “All animals are equal, but some animals are more equal than others.” So ends George Orwell’s sobering classic novel, Animal Farm.
 
One danger of advanced technology in the insurance industry has been the “commodity mentality”.
 
Created by the ease and prevalence of spread-sheeting the premiums for any of a broad array of available term products as a starting point for a choice of carrier. Unfortunately the numbers generated are too often the end point as well. It becomes “all about cost” and an agent will recommend Texas Life and Limb because the coverage is a nickel cheaper a month.
 
But a wise advisor looking beneath the price tags will find that, similar cost notwithstanding, some term products are more equal than others.
 
The most important feature of any term policy is the conversion option.
 
The privilege of exchanging the policy for the carrier’s permanent product at the original medical classification without new underwriting. An insured may come to the end of the guaranteed level premium period only to find that he or she has a need for, at least some of, the coverage going forward.
 
There are three options:
  1. Pay the onerous and rapidly accelerating one-year term rates, or
  2. if still in good health, shop for the best price on permanent coverage, or
  3. if there have been health incidents during the level premium period, exercise the right of conversion under the existing contract – and the terms and conditions of that conversion option are where the thrill of a lower cost can be quickly forgotten.
Consider:
  • What permanent products are available for conversion? The most generous carriers allow for conversion to any permanent product in the portfolio at the time the option is exercised. Other carriers restrict the choice to certain contracts now, which may or may not be available later.
  • What is the likelihood that available products will be competitive? Consider term insurance with a carrier that has a reputation for and exhibits a likelihood for future generation of competitive permanent products.
  • How long into the life of the term product is the conversion privilege available? Some policies allow conversion for the full level premium period. Some only to a certain age. Some only for a set number of years, even if less than the level premium period.
  • How much flexibility is there in the amount and segmentation of conversion elections? Can only part of the coverage be converted? Can it be converted in stages?
Nothing will de-commoditize an advisor’s approach to term more quickly than a close examination of the conditions of the policy’s conversion privilege. For assistance in making the best term choice for your client’s situation, all factors considered, contact your Life Sales Representative.
 
Lest readers think that all scary characters in literature are equal, AbeBooks.com conducted a worldwide poll to determine the scariest. The winner was Big Brother, from George Orwell’s other famous dystopic novel, 1984, edging out Hannibal Lecter from the pen of author Thomas Harris.
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Insuring Key Signal-Callers

Why is it good to have a runner on second base? Two reasons: first, he’s in “scoring position” where a well-placed single will drive him home; and second, he can see the signals the catcher is giving the pitcher and pass them on to the batter. In this subtle game of refined skills, anticipating the correct pitch turns even a mediocre hitter into Ty Cobb on the next throw to the plate.
 
The savvy fan is aware of the importance of the ongoing flurry of signals that continually circulate the field as players communicate information, strategies and intentions. He or she is also aware that most originate somewhere in the dugout from one of several players or coaches, all making gestures to confuse and mislead the opponent as to their source.
 
And so it is, sometimes, with businesses whose success is often, in part, because of influence and input from people on the sidelines not involved in the day-to-day activity of the business. Let’s call them key directors.
 
Consider this:
 
Sometimes a position on the Board of a company is an honorary thing, much like sitting in the celebrity box for the Macy’s Thanksgiving Day Parade. More often it entails involvement in decisions and policies whose resolution and implementation require a level of street-smarts and industry background.
 
But, sometimes a director’s input is so impactful that the untimely loss of his or her services could have an adverse economic impact on the business. A little company-owned coverage on such a director might seem wise and in order.

The problem is that carriers don’t traditionally recognize the importance of these off-field signal-callers for purposes of financially justifying any coverage applied for by the business.

But, as always, there is a crack in the door that affords an opportunity if a good case is made.
 
Even if convinced of a director’s unusually disproportionate importance, two things works against a carrier’s standard criteria for granting key person coverage: 1) the director is not an employee and 2) the director has little or no compensation on which to apply the “ten-times annual compensation formula”, employment status notwithstanding.
 
In a recent case we experienced success in getting a carrier to consider modest amounts of coverage ($250,000) on directors where their contributions to the economic well-being of the company was adequately demonstrated, and where they were paid a respectable modicum of compensation ($2,000 a year and $1,000 per meeting), and the company was taking steps to insure its traditionally-defined key people using the standard coverage guidelines. The success on this small matter has allowed the agent to begin personal planning for two of the key people.
 
Back to baseball. So potentially beneficial is the knowledge of a rival’s signals that teams have been known to put a mole in the centerfield bleachers with binoculars to monitor the opposing catcher’s instructions to the pitcher. Recently the FBI has shown interest in investigating allegations of hacking the data bases of opposing teams for information. Oh my! What happened to the good old days when a strategy of success was as simple as Honus Wagner’s remark, “I just hit ‘um where they ain’t?”
 
Contact us with questions or for information on all your key person opportunities, especially those outside the common case parameters – at 706-614-3796 or tom@cpsadvancedmarkets.com.
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Giving A Vanilla Non-Qualified Fringe Benefit More Flavor

He may be old news now, but Jay Leno was very big news back in 1992 when took charge of The Tonight Show, replacing the “King of Late Night,” Johnny Carson, who had dominated post-primetime ratings for 30 years.  A stand-up comedian by trade, Leno liked to joke that he had three steps in his job description:  Write joke.  Tell joke.  Get check!

Too often we tend to think just as simply regarding executive bonus plans, the most flexible and least complicated benefit in the non-qualified marketplace:  Offer benefit.  Buy policy.  Write check!

In fact, as show host Leno had to significantly broaden his approach to handle the greater responsibilities of his new role.  And we should do the same to demonstrate how a broader executive bonus plan might be the most attractive and most versatile way to lock in key employees.

Consider how an employer-sponsored, executive-owned plan can address a far-reaching array of risk management needs:
  • Income Replacement 101 – A person’s most valuable asset is the ability to generate income.  Dollars spent on an executive bonus plan don’t have to be committed to life insurance.  Consider using a portion of the plan cost for an income replacement policy to provide tax-free dollars if disability occurs during working years.
  • Income Replacement 102 – Pre-mature death will also deny an employee’s family income.  Benefit dollars can also be used to economically fund a term insurance policy large enough to replace the income that was anticipated over the remaining years of a key employee’s working life.
  • Estate Liquidity – Employees with death tax issues aren’t the only ones who need liquid flexibility to assure effective settlement of their estate.  Consider funding a portion of the death coverage for income replacement with a permanent policy which will provide cash in the estate for the life of the employee.
  • Critical Illness and Long-term Care Expenses – Nothing can unexpectedly disrupt sufficient growth of net worth for retirement more than either of these two events.  Life policy riders can economically offer protection, especially if added to permanent coverage already intended as part of the executive bonus plan.
Two planning suggestions will further enhance the attractiveness and value of the plan:
  • Avoid sticker-shock – The benefit cost is deductible to an employer, but forewarn the plan participant that the amount will appear on next year’s W-2.  Even better, determine the amount to spend on the plan, withhold the anticipated tax due, and then spend only the balance on coverage.
  • Make it a true lifetime benefit – Structure premium schedules that result in paid-up policies, making it unnecessary for the employee to incur cost to carry coverage beyond retirement.

To further discuss this “super executive bonus” concept, or any advanced marketing issues in your casework, contact Tom Virkler at 706-614-3796 or tom@cpsadvancedmarkets.com.

For What It’s Worth:  Relying on income from other sources, Jay Leno never spent the money from the checks for his $10-15 million salary from The Tonight Show.  His net worth is estimated at around $500 million.  He currently hosts Leno’s Garage which features his $52 million collection of classic automobiles.

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The Big, Beautiful Bill Doesn’t Protect Against Big, Ugly State Death Taxes

From a recent 911 call transcript…

Operator: This is 911.  What’s your emergency?
Caller: I need help!  I just broke my leg because a car hit me on Susquehanna Street!
Operator: Can you please spell Susquehanna?
Caller: [after a pause] Hold on a minute while I limp over to Main Street.

Location can dramatically affect an outcome.  This is especially true for high-net-worth clients who may be protected by the recently passed $15,000,000 federal transfer tax lifetime exemption but live in or have property in a state that imposes its own death tax.

Washington is a good example.  The “Ever-green” State is turning bright red as it anticipates a $16 billion annual budget deficit.  In response it recently passed a comprehensive tax overhaul package.  Even after an increase in its death tax lifetime exemption, the estate of domiciled taxpayers dying after July 1, 2025, can only protect the first $3,000,000 of state-based assets, the rest being subject to a progressive tax rate that tops out at 35% on amounts over $9,000,000.

To illustrate the potential exposure:  Next year a single taxpayer with a net worth in Washington assets around $15,000,000 may avoid any federal transfer tax but could still anticipate a state tax of over $4,000,000!

Two planning resources:  First, check to see if the state in question has a death tax.  Over half of them do!  A good point of reference is John Hancock’s Know the Law portion of its website at Tools and Calculators for Advanced Markets.

Next, if there is a state tax concern, and certainly if there is a potential federal tax, call us for an easy-to-understand, two-page death tax estimate to use with your client and any advisors.  All we need is marital status, approximate net worth, state of domicile, and two suggested net rates of growth for the estate.

It may prove worthwhile finding ways for all or part of that taxable estate to limp over to a kinder and gentler jurisdiction.

Beyond that, the most common planning device for dealing with unavoidable anticipated taxes is the use of life insurance to pay the bill, usually held outside the taxable estate in an irrevocable trust.  We will assist in talking with you to your clients and their legal and tax advisors about the opportunities they have to minimize estate and gift taxes.  Call Tom Virkler at 706-614-3796 or tom@cpsadvancedmarkets.com.

For What It’s Worth:  In 2022 a study by the Vera Institute of Justice reported that Seattle, WA, had one of the highest percentages of 911 calls relating to violent crime.  There is no data yet to determine if the hike in the death tax has affected that one way or the other.

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SCOTUS Also Adds When It Should Subtract – So Check Every Buy-Sell Out There

We’re all familiar with the old brainteaser:  Three men check into a hotel and pay $10 each for a $30 room.  The owner later decides to give them a discount and sends the bellhop back with a $5 refund.  But he only returns $1 to each guest and pockets the other $2.

Question:  So… if the guests ended up paying only $27 ($9 each) and the bellboy kept $2, the total is $29.  What happened to the other dollar from the original $30?  Answer:  We’re adding when we should be subtracting.  From the initial $30 subtract the $3 refund.  Then from the remaining $27 subtract the $2 scarfed by the purloining porter leaving the remaining $25 that is down in the till at the front desk.

The Supreme Court kinda did the same thing in the case of Connelly v. U.S (that we have discussed before).  In a nutshell, the high-net-worth Connelly brothers owned a building supply company and agreed that when either of them died the company would redeem the deceased’s interest at an agreed price.  The company owned life insurance on each to fund the redemption.

Since, at least, the discovery of the New World, all have agreed that valuing a business for estate tax purposes under an insurance-funded redemption agreement meant off-setting the amount of incoming death proceeds by the amount of company’s redemption obligation. 

But all nine of the Justices added when they should have subtracted by including the death benefits in the business’s FMV, ignoring any valuation counterbalance by the obligation to redeem.  And it cost the wealthy Connelly family significantly.

Despite the poor reasoning of the Court, the ruling had extremely limited adverse effect because:
  • It only has estate tax consequences for super-high-net worth business owners (given the permanent $15,000,000 lifetime exemption under the One, Big, Beautiful Bill).
  • And then only if the taxpayer has a buy-sell agreement in place with a redemption format (vs. a cross-purchase structure).
  • And then only if it is funded with business-owned life insurance.

Nonetheless, the decision serves as a good conversation starter for follow-up with every client or prospect with a business interest.  The fact is that many businesses have not done sufficient buy-sell planning and many that have 1) have not updated them recently, and/or 2) have not funded them properly, and/or 3) have redemption-type agreements which are usually not the best way, regardless of any Supreme Court rulings.

Call to discuss any buy-sell case planning questions or to plan a conference or Zoom call with your client and/or their advisors concerning steps they should consider with you – Tom Virkler at 706-614-3796 or tom@cpsadvancedmarkets.com.

For What It’s Worth:  Speaking of popular math questions – If all we knew about the Connelly siblings was that there was only two and that one of them was male, what would have been the odds that the other was also a male?

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The Business Of The Family Business

The late Justice Antonin Scalia already had experience working with “a group of nine” when appointed to the Supreme Court in 1986.  He was the father of five sons and four daughters.  Being a conservative on matters of law he was often questioned concerning his oldest offspring whose opinions were more liberal than his own.  The Justice replied, “In a big family the first child is kind of like the first pancake.  If it’s not perfect, that’s okay, there are a lot more coming along.”

When children of SCOTUS fall far from the tree it makes good media copy.  When it happens in a family with a business it creates significant planning problems. 

Consider three common concerns when only some of a business owner’s offspring choose to follow in the footsteps of their entrepreneurial parent.

Playing percentages in the will.

The most typical dispositive instruction for an estate left to children gives each an equal fraction of the property.  This is fine so long as the testator believes that differences regarding the allocation of interest in a particular asset can be resolved without an issue.  But when a business owner intends that only certain children are to inherit the business his or her intentions must be expressed in a specific direction that the business go to the share of only intended future owners.  Instructions about who should and shouldn’t inherit a business must be exact and unambiguous and, better yet, understood by all prior to death.

The elephant in the room.

This can be a problem if the business accounts for too much of the estate’s value leaving too few non-business assets to non-business children.  But there are solutions.

If either or both parents are insurable, life insurance can be used to bring additional value (and liquidity) allowing for a larger and more flexible estate distributed without unintended business ownership by disinterested children.  Make sure the purchase of life insurance for estate equalization doesn’t create financial underwriting issues.  Also, address whether inheritance tax problems won’t be created or aggravated?

An intra-family buy-sell agreement may cover a multitude of sins.  The child who will carry on the business can have the right to purchase any interest transferred to other children.  The buying child can own the coverage on the parent to make the purchase.  This might also serve to alleviate financial underwriting questions and keep the proceeds out of the estate.  If the parent is uninsurable steps should still be taken to arrange an unfunded agreement that would allow for purchase of any scattered interests on terms as manageable as possible to all.

Employing Peter to pay Paul.

Often a child that goes to work in the family business becomes more capable, most valuable and more beneficial to the company as time goes by.  He or she accepts more responsibility, contributes more hard work and is involved in more decisions that increasingly contribute to the success and the net worth of the enterprise.  The child can make a legitimate argument that at least a part of the company’s value should not be considered in the estate hotchpot that is to be divided equally among other brothers and sisters who did not contribute.

Two common planning techniques that could recognize a participating child’s role in enhancing company value are either an increase of compensation or the adoption of a program of lifetime transfers of interest in the business.

The second is often accomplished by restructuring the business as a family limited liability company with non-voting interests.  This allows the parent to maintain control of the business regardless of the percentage of interest transferred during life.  Transfers (and their increases in value) are removed from estate tax liability, often with a valuation discount for gift tax purposes.

In the new high-lifetime-exemption tax environment, this is only one example of a common ongoing life insurance need for high-net-worth clients who may not have estate tax issues.  Call Tom Virkler for further case discussion at 706-614-3796, or tom@cpsadvancedmarkets.com!

For What It’s Worth:  The Guinness record-holder for most pancakes served in eight hours is the IHOP in Santa Monica, CA, which served 25,629 pancakes to 8,543 guests earlier this year.  Only the first customer had any complaints!

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