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Tax and Financial Planning for the Closely Held Family Business

Gary A. Zwick and James J. Jurinski

Tax and Financial Planning for the Closely Held Family Business serves as a manual to help business advisers devise strategies for clients dealing with family issues. Guiding family businesses through the complex maze of organizational, tax, financial, governance, estate planning, and personal family issues is a complex, time-consuming, difficult, and sometimes emotional process. This book focuses not only on identifying the problems family businesses face, but on devising solutions and planning opportunities for both family businesses and their owners. Each chapter of this book contains creative planning opportunities that advisers can suggest and help implement in order to solve real problems in the family business.
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EXTENDED CONTENTS

Gary A. Zwick and James J. Jurinski

Table of cases

Table of legislation

1    THE MANY ROLES OF THE FAMILY BUSINESS ADVISER

A. Characteristics of a “family business” 1.002

1. Corporate culture and family values 1.007

2. Profile of the American family business 1.010

3. Employment practices 1.013

B. Recognizing owners’ goals 1.015

1. Financial security for the family 1.016

2. Family business as a legacy 1.017

3. Family harmony 1.020

4. Perpetuation of the business 1.023

5. Planning complexity 1.024

C. Importance of “soft” issues 1.025

D. Four phases in resolving problems 1.026

E. Recurring planning issues 1.027

1. Addressing issues 1.028

2. Family conflicts 1.029

3. Power struggles, squeezeouts, and deadlocks 1.030

4. Protection of minority shareholders 1.031

5. Compensation techniques 1.032

6. Retirement planning 1.033

7. Succession issues 1.034

8. Estate planning 1.035

9. Intra-family transfers 1.036

10. Liquidity planning 1.037

11. Valuation 1.038

12. Life insurance planning 1.039

13. Financing 1.040

14. Income tax problems 1.041

15. Related-party rules 1.042

F. Overcoming the client’s reluctance to engage in planning 1.043

G. “Who” is the client? 1.047

2    UNDERSTANDING FAMILY BUSINESS

A. Why family businesses are different 2.001

B. Family business models 2.009

C. Two-circle model 2.011

D. Three-circle model 2.014

E. Family systems versus business systems 2.019

F. Conflict areas 2.028

1. Decision-making process 2.032

2. Participation in the business 2.035

3. Pay 2.037

4. Succession 2.039

G. Nonparticipants’ roles 2.040

1. Sons and daughters 2.040

2. Spouses 2.044

H. Developmental stages 2.046

1. Family development 2.047

2. Ownership development 2.050

3. Business development 2.053

4. The entrepreneur 2.059

5. Succession planning 2.065

I. Intervention to solve serious problems 2.066

1. Recognizing serious problems 2.066

2. Goals if intervention is appropriate 2.075

3    FAMILY ISSUES IN FAMILY BUSINESS OPERATIONS

A. Introduction 3.001

B. Addressing “soft issues” 3.006

C. Critical moments in the life of the business 3.008

D. Appreciating the family business culture 3.015

1. Family systems 3.017

2. Family evolution 3.024

3. What is a family? 3.027

E. Communication problems 3.030

F. Decision-making style 3.038

G. Family conflicts 3.042

1. Varying expectations 3.048

2. Risk tolerance 3.053

3. Business strategy 3.055

4. Cash needs and compensation policy 3.059

5. Disability expectations 3.063

6. Family personality conflicts 3.066

H. Anticipating marital problems 3.068

1. Impact on the business 3.069

2. Impact on the individuals 3.072

3. Divorce rules 3.076

4. Prenuptial agreements 3.082

5. Validity of prenuptial agreements 3.085

6. Features of prenuptial agreements 3.090

7. Other techniques to protect the business 3.094

8. Divorce taxation rules 3.096

9. Redemptions 3.104

I. Business problems 3.120

1. Problems employing relatives 3.120

2. Employing younger family members 3.125

3. Employing older family members 3.128

4. Substance abuse 3.131

J. Solutions 3.134

1. Role of the adviser 3.134

2. Avoid taking sides 3.137

3. Family meetings and retreats 3.140

4. Outside boards 3.146

5. Family mission statement 3.150

6. Strategic planning 3.151

7. Family constitutions 3.156

8. Alternative dispute resolution for family disputes 3.164

9. Resolving disputes through mediation 3.167

10. Family councils 3.187

4    DEALING WITH POWER STRUGGLES AND PROTECTING MINORITY SHAREHOLDERS

A. Introduction 4.001

B. Underlying reasons for power struggles 4.002

1. Lack of planning and professional advice 4.002

2. Entrances and exits 4.008

C. Sources of conflict 4.015

1. Lack of succession plan 4.015

2. Rivalries 4.017

3. Hanging on too long 4.020

4. Family problems 4.022

5. Personality conflicts 4.025

6. Personal ambitions and self-interest 4.029

7. Lack of professional management 4.032

8. Inept relatives 4.034

9. Differing expectations 4.036

10. Philosophical differences 4.038

11. Compensation issues 4.042

D. Forcing a buy-out 4.044

E. Squeezeout techniques 4.046

1. Eliminating participation on board of directors 4.048

2. Withholding dividends 4.049

3. Excluding relatives from employment 4.050

4. Redeeming majority shareholders’ stock 4.051

5. Improper use of business assets 4.054

6. Loans, sales, and leases 4.055

F. Deadlocks 4.057

G. Solutions – preventative planning 4.058

H. Dissolution 4.062

i. Protecting minority shareholders 4.064

1. Family minority shareholder 4.070

2. Non-family minority ownership 4.075

3. Lack of transferability 4.078

4. Fiduciary duty of majority shareholders 4.081

J. Stock restrictions 4.082

K. Types of restrictions 4.084

1. Board or shareholder approval 4.085

2. Right of first refusal 4.086

3. Mandatory sale 4.089

4. Prohibition on transfer to specific party 4.090

L. Validity of restrictions 4.092

M. Mechanics of restricted stock 4.093

N. Restrictions in buy-sell agreements 4.099

O. Other devices to protect minority shareholders 4.102

1. Supermajorities 4.105

2. High quorum requirements 4.107

3. Cumulative voting 4.108

4. Preemptive rights 4.111

P. Voting and trust agreements 4.112

1. Traditional voting agreements 4.112

2. Pooling agreements 4.113

3. Voting trusts 4.114

4. Directors’ agreements 4.118

Q. Solutions to deadlocks 4.120

1. Split-ups 4.121

2. Buy-outs 4.123

3. Going public 4.125

4. Involuntary dissolution 4.126

R. Sales to outsiders 4.127

1. Sales as a solution 4.127

2. Non-tax concerns 4.129

3. Tax factors 4.138

4. Impact on estate planning 4.145

5    CREATIVE COMPENSATION TECHNIQUES FOR FAMILY BUSINESSES

A. Introduction 5.001

B. Family businesses versus other businesses 5.002

C. Non-tax considerations 5.004

1. Compensating family executives 5.005

2. Compensating non-family executives 5.013

3. Financial statement issues 5.015

D. Tax considerations – overriding goals 5.019

E. Tax considerations – benefit of capital gains rates 5.025

F. Tax considerations – FICA and Medicare tax planning 5.027

G. Types of compensation 5.041

1. Cash compensation 5.042

2. Deferred compensation 5.043

3. Stock compensation – restricted and unrestricted 5.055

4. Phantom stock or units 5.065

5. Stock appreciation rights 5.073

6 Stock options 5.076

7. Section 409A 5.093

H. Income and payroll tax issues 5.116

1. Unreasonable compensation 5.117

2. Constructive receipt 5.124

3. Owner/employee issues 5.126

4. The interaction of compensation and the QBID 5.128

I. Creative planning 5.131

1. Deferrals 5.132

2. Stock bonus for family members 5.136   

3. Deferred compensation for children while parents own the company 5.137

4. FICA and other payroll tax planning 5.139

5. Planning with non-statutory options in S corporations 5.148

6. Compensation with insurance 5.149

7. Section 105(c) plans 5.150

8. State and local taxation of deferred compensation for retiring owners 5.151

9. Separate companies for children and/or executives 5.157

10. Management companies 5.161

11. Golden handcuffs 5.162

12. Disability insurance 5.167

6    CREATIVE RETIREMENT PLANNING FOR FAMILY BUSINESS OWNERS AND THEIR FAMILIES

A. Introduction 6.001

B. Potential problems 6.003

C. Qualified versus non-qualified plans 6.005

D. Qualified plans 6.006

1. Comparison of tax situation with and without qualified plans 6.007

E. Non-qualified plans 6.011

1. Benefits of non-qualified plans 6.012

2. Disadvantages of non-qualified plans 6.013

3. ERISA requirements 6.018

4. Top-hat plans 6.019

5. Severance pay plans 6.020

6. Common names to identify non-qualified plans 6.022

F. Special considerations with multiple family members or related entities 6.023

1. Controlled group rules 6.024

2. Attribution rules 6.028

3. Businesses under common control 6.032

4. Affiliated service groups 6.034

5. Leased employees, owners and directors 6.038

G. Qualified plan design 6.042

1. Types of plans 6.043

2. Skewing benefits toward family owners 6.066

3. Creative uses in family succession, buyouts, and wealth transfer to children 6.077

H. Distribution planning 6.079

1. Tax effect of combined income and estate taxes 6.080

2. Beneficiary designations 6.082

3. Survivors’ rights in pension plans 6.088

4. Benefit options 6.091

5. Pensions and divorce 6.092

6. Estate planning and pension plans 6.093

I. Stretching out distributions 6.094

J. Overview of taxation 6.096

1. Income taxation of retirement income 6.097

2. Lump-sum payment 6.098

3. Long-term capital gain treatment 6.100

4. Roth IRA, Roth 401(k), and conversions to Roth IRA 6.104

5. Withholding 6.109

6. Rollovers 6.112

7. Spousal rollovers 6.115

8. Divorced spouses 6.117

9. Spousal rights 6.120

K. Special problems in planning 6.123

1. Estates with large qualified plan assets 6.124

2. Impact of family attribution 6.126

3. Liquidity problems 6.129

7    SOLVING PROBLEMS IN SUCCESSION PLANNING FOR FAMILY BUSINESSES

A. Dealing with emotions 7.001

B. The adviser’s role 7.005

C. Four questions for the client 7.013

D. Understanding family dynamics 7.032

E. Selecting the successor 7.047

F. Consequences of failing to plan ahead 7.056

G. Developing a formal succession plan 7.062

H. The founder’s post-succession role 7.077

I. Outsider successor 7.083

J. Co-successors 7.086

8    CREATIVE ESTATE PLANNING TECHNIQUES FOR BUSINESS OWNERS AND THEIR FAMILIES

A. Introduction 8.001

B. Unique aspects of family business interests 8.004

C. Combining aspects of estate planning, transfer planning, financial planning, retirement planning, asset protection planning, and income tax planning 8.005

1. Issues covered in other chapters 8.008

D. Overview of estate planning 8.009

1. Portability 8.014

2. The transfer tax calculation 8.024

3. What is included in the estate 8.025

4. Deductions in arriving at the estate tax 8.027

5. Marital deduction 8.028

6. Charitable deduction 8.035

7. Deduction for losses and expenses of administration 8.038

E. Pattern estate plans 8.040

1. The married client 8.041

2. The second marriage 8.043

3. The single client 8.046

F. Creative estate tax planning techniques that family business owners may utilize 8.048

1. Avoiding tax traps 8.049

2. Transfer for value 8.053

3. Life settlements 8.056

G. Lifetime gifting 8.059

H. Gift splitting 8.065

I. Leveraged gifting 8.067

1. Subtraction method of valuation and its use in various estate planning techniques 8.069

J. Generation-skipping transfers 8.075

1. Dynasty trusts 8.087

2. Judicious use of the generation-skipping tax exemption 8.091

3. Reverse QTIP election 8.093

4. Other transfers not subject to marital deduction 8.096

5. Crummey powers 8.097

K. Taxable versus non-taxable gifts 8.100

L. Net gifts 8.104

M. Family limited partnerships, grantor retained annuity trusts and qualified personal residence trust 8.107

N. Charitable planning 8.108

1. Philanthropic funds and donor-advised funds 8.110

2. Gift annuities 8.111

3. Charitable remainder annuity trusts 8.112

4. Charitable remainder unitrusts 8.116

5. Private foundations 8.122

6. Charitable lead trusts 8.125

9    SPECIAL PROBLEMS IN IMPLEMENTING INTRA-FAMILY TRANSFERS

A. Non-tax issues 9.002

B. Succession planning 9.005

C. Liquidity planning 9.006

D. Risks in intra-family transfers 9.007

E. Tax goals 9.008

F. Transfer techniques 9.009

G. Choice of techniques 9.011

H. Sale transactions 9.012

I. Freezing the value of senior interests 9.014

J. Outright sales and installment sales and self-canceling installment notes 9.016

K. Private annuities 9.021

L. Self-canceling installment notes 9.027

M. Gifts 9.033

N. Interaction of income tax and transfer taxes 9.036

O. Grantor retained annuity trusts 9.039

P. Sale to defective grantor trust 9.049

Q. Charitable remainder trusts 9.055

R. Unitrusts versus annuity trusts and variations 9.059

S. Family limited partnerships 9.064

1. Overview 9.064

2. Mechanics 9.066

3. Non-tax advantages 9.069

4. Tax advantages 9.071

5. IRS challenge 9.074

T. Combining techniques 9.076

U. Corporate redemptions to shift control 9.079

V. Post-mortem techniques 9.086

W. Special-use valuation: Section 2032A 9.090

X. Employee stock ownership plans 9.091

1. Planning with S corporation ESOPs 9.099

Y. Intra-family buy-sell agreements 9.102

Z. Grandfathering 9.109

AA. Divorce 9.110

AB. Wealth transfer through new company formation 9.115

AC. Conclusion 9.117

10   CREATIVE TECHNIQUES TO PROVIDE ESTATE LIQUIDITY

A. Causes and consequences of illiquidity 10.001

B. The estate plan 10.005

C. Life insurance planning 10.007

D. Valuation 10.011

E. I.R.C. Section 6161: 12-month extension to pay estate tax 10.014

F. I.R.C. Section 6166: ten-year extension to pay 10.019

G. I.R.C. Section 6166: overview 10.020

H. Amount of deferral 10.021

I. Requirements 10.024

J. Meeting the 35 percent test 10.033

K. Calculation of the deferral 10.037

L. Interest 10.038

1. Graegin loans 10.039

M. The election 10.045

N. Withdrawals and dispositions 10.049

O. The need for advance planning 10.050

P. Other extensions 10.053

Q. Section 303 redemptions 10.054

R. Income tax consequences 10.055

S. The 35 percent rule 10.058

T. Dollar limitation 10.060

U. Advance planning 10.062

V. Making the election 10.067

W. Using life insurance to fund the redemption 10.068

X. Reviewing the plan 10.072

Y. Liquidity analysis 10.073

11   VALUATION TECHNIQUES AND STRATEGIES TO MINIMIZE TAXES ON FAMILY BUSINESSES

A. Introduction 11.001

B. Purpose of the valuation 11.003

1. Effect on value 11.004

2. Publicly traded vs. closely held corporations 11.015

3. Strategies for valuation reports 11.018   

4. Penalties 11.022

C. Rev. Rul. 59-60 11.024

1. Concept of the willing buyer and willing seller 11.025

2. Eight valuation factors 11.032

3. Practicality of comparing private and public companies 11.044

4. Effects of bona fide offers and recent transactions on valuation 11.045

5. Effect of industry rule-of-thumb valuations 11.047

D. Valuation discounts 11.053

1. Lack of control 11.054

2. Lack of marketability 11.057

3. Blockage discounts 11.058

4. Stock restrictions 11.059

5. Swing vote attributes 11.061

6. Potential whipsaw-control premium 11.062

7. Limitation on discounts – the willing seller 11.064

E. Miscellaneous issues 11.065

1. Effect of capital gains and built-in gains taxes on valuation 11.065

2. Range of discounts, expected IRS reactions 11.066

F. Planning opportunities and issues 11.069

1. Buy-sell agreements 11.069

2. Family limited partnerships restrictions affecting valuation 11.080

3. Lapsing restrictions – I.R.C. Section 2704 11.081

4. Tiered entities 11.083

5. IRS attack of discounts under I.R.C. Section 2036 11.084

6. FLP court cases under a variety of theories 11.088

12   CREATIVE LIFE INSURANCE PLANNING FOR FAMILY BUSINESSES

A. Introduction 12.001

B. Types of insurance 12.004

1. Term insurance 12.005

2. Whole life 12.012

3. Universal life 12.016

4. Variable life 12.021

5. Term/whole life mix 12.024

C. Special features 12.026

1. Paid-up additions 12.027

2. Disability and waiver of premium riders 12.028

3. Other features 12.030

D. Reviewing life insurance proposals 12.033

1. Variables 12.036

2. Cost indices 12.041

3. Vanishing premium and single premium 12.043

4. Endowing at age 100 12.046

5. “Skinny universal life” 12.047

6. Due diligence 12.048

7. Rating services 12.052

8. Loaded versus no-load policies 12.058

E. Purposes of life insurance 12.060

1. To pay estate tax 12.061

2. Estate builder 12.063

3. Funding a buy-sell agreement 12.064

4. Key man insurance 12.065

5. Investment 12.071

6. Compensation 12.072

7. Provide for family on premature death 12.075

8. Leveraged charitable and family gifting 12.081

F. Financing the purchase of life insurance 12.084

1. Borrowing to purchase 12.085

2. Split-dollar arrangements 12.088

3. Use of qualified plan money 12.098

4. Welfare benefit plan 12.102

G. Overview of tax aspects of life insurance 12.105

1. Tax-exempt proceeds 12.106

2. Tax-free withdrawals 12.112

3. Non-deductability of premiums 12.113

4. Estate tax aspects 12.117

5. Gift tax aspects 12.125

H. Creative planning ideas 12.128

1. Use of irrevocable life insurance trust (ILIT) 12.129

2. Use of partnership to hold insurance 12.131

3. Structuring buy-sell arrangements 12.133

4. Avoidance of the three-year rule 12.142

5. Intergenerational split-dollar to reduce estate tax 12.146

6. Life insurance in qualified plans 12.147

7. Removing life insurance from a corporation or other entity 12.153

8. Wealth replacement 12.155

9. GST planning 12.159

10. Crummey powers 12.161

11. Life insurance on multiple lives 12.166

13   FINANCING PROBLEMS AND ISSUES

A. Introduction 13.001

B. Financing on formation of the entity 13.003

1. Debt/equity ratio 13.004

2. Investment company rules 13.021

3. Small business corporation tax rules 13.022

4. Bank financing 13.038

5. Loans from shareholders and family 13.040

6. Crowdfunding 13.045

C. Financing day-to-day operations 13.048

1. Difficulty in accumulating capital 13.051

2. Leasing versus buying 13.056

3. Asset-based financing 13.071

4. Leverage 13.073

5. Other sources of funds 13.074

D. Sources of capital for expansion and buy-out 13.081

1. Bank financing 13.083

2. Selling off unneeded assets 13.084

3. Bringing in a new partner 13.085

4. Venture capital 13.086

5. Government loan programs 13.089

6. Going public 13.091

7. Use of employee stock ownership plans 13.095

14   INCOME TAX PLANNING OPPORTUNITIES FOR FAMILY BUSINESSES AND OWNERS

A. Introduction 14.001

B. Interrelationship of business and individual planning 14.002

C. Choice of entity 14.006

1. C corporations 14.009

2. S corporations 14.022   

3. Partnerships 14.027

4. Limited liability companies 14.033

5. Corporate general partners 14.035

6. “Check-the-Box” Regulations 14.037

7. Other business trust and tax-exempt entities 14.039

8. Qualified business income deduction (QBID) 14.043

9. Section 1202 stock 14.048

D. Family considerations 14.051

1. Active versus inactive owners 14.052

2. Disproportionate allocations of profits 14.055

3. Estate planning considerations 14.056

4. Salaries versus distributive share of profits 14.058

E. Changes in form of entity 14.062

1. C corporation to – 14.068

2. S corporation to – 14.076

3. Limited liability company or partnership to – 14.089

F. Selection of accounting periods and methods 14.094

1. Accounting methods 14.096

2. Accounting periods 14.105

G. Changing fiscal years 14.121

H. Planning opportunities 14.125

1. Income shifting among family members 14.126

2. Using the C corporation for tax shelter 14.131

3. Multiple entities for the best of all worlds 14.134

4. Planning with the selections of the accounting methods 14.135

5. Management and related companies 14.136

6. Section 105(c) plans 14.138

7. Medical reimbursement plans 14.139

8. Interest charged domestic international sales corporation 14.140

9. Employing minor children 14.141

15   NEGOTIATING THE TAX CODE’S RELATED-PARTY RULES

A. Introduction 15.001

B. Controlled groups 15.002

C. Transactions between spouses 15.010

D. Installment sales 15.017

1. Related-party installment sales of depreciable property 15.024

E. Capital gain versus ordinary income 15.027

F. Loss transactions between related parties 15.030

G. Accrued expenses between related parties 15.035

H. Compensating family members 15.040

I. Taxation of regular corporations and their shareholders 15.044

J. Anti-churning and other rules 15.057

K. Chapter 14 valuation rules 15.061

L. Minority discounts 15.073

M. Sales of passive activities to related parties 15.077

N. Employee stock ownership plans 15.083

O. Conclusion 15.087

16   COMPREHENSIVE CASE STUDY

A. Introduction 16.001

B. Start-up phase 16.002

C. Considerations in start-up 16.005

1. Options for selection of entity 16.007

D. Selection of fiscal year 16.016

E. Selection of accounting method 16.020

F. Building a business and building wealth 16.023

1. Retirement plans for wealth building 16.025

2. Funding for college 16.026

3. Early estate planning 16.028

G. Tom goes to work elsewhere – Tina joins the family business 16.029

1. Succession 16.030

2. Next phase estate planning 16.031

3. Asset allocation/portability 16.033

4. Anticipating future increases 16.034

H. Good fortune and larger problems 16.035

1. Defining the problem 16.038

2. Potential strategies 16.039

I. Planning for the large estate 16.057

1. Survey of additional planning ideas 16.058

2. Make additional gifts 16.059

3. Family split-dollar 16.061

4. Charitable lead trusts 16.062

5. Combining a private annuity and a GRAT 16.063

6. Short-term GRATs 16.064

7. Private foundations and supporting organizations 16.065

J. Practical business planning 16.067

1. Governance issues 16.070

2. Bringing children into the business 16.073

3. Business tax issues 16.076

K. Considerations for Tom and Tina 16.083

L. Liquidity and payment of estate tax 16.086

Index