Annapolis, Maryland Wills, Trusts & Estate Planning

Tax Traps Can Ruin IRA Status - Annapolis Estate Planning

You may know that there are tax traps when IRA withdrawals or rollovers are done incorrectly. However, did you know that an investment portfolio could contain a tax trap that could ruin your IRA status?

The most frequently occurring IRA tax trap comes from tax bills through the Unrelated Business Taxable Income (UBTI). Sources of business income from stocks, bonds and funds like interest income, capital gains and dividends are exempt from UBTI and a related tax, the Related Business Income Tax.

Fox Business’s recent article, “Your IRA and taxes: Don't get a surprise tax bill” explains that IRAs that operate a business, have certain types of rental income, or receive income through certain partnerships will be taxed when the total UBTI exceeds $1,000. This is to prevent tax-exempt entities from gaining an unfair advantage on regularly taxed business entities.

UBIT can take a chunk from an IRA, and the Tax Cuts and Jobs Act of 2017 replaced the tiered corporate tax structure with a flat 21% tax rate. That begins in tax year 2018 (this tax season). These tax bills often have penalties because IRA owners aren’t even aware that the bill exists.

Master Limited Partnerships (MLPs) held within IRAs are a good example of how UBTI can catch investors by surprise. MLPs are fairly popular investments, but when they’re held within an IRA, they’re subject to UBIT. When the tax is due, the IRA custodian must get a special tax ID number and file Form 990-T to report the income to the IRS. That owner must pay the tax, and is typically unaware of the bill, until it arrives as a completed form to be submitted to the IRS (completed and signed on behalf of the owner). In some instances, the owner may have to pay estimated taxes throughout the year. This can mean a significant underpayment penalty.

Working with prohibited investments will also result in a tax bill. Self-directed IRAs can violate the rules. Alternative investments such as artwork, antiques, and precious metals (with some exceptions) are generally considered distributions and are subject to taxes.

Prohibited transactions are a step above prohibited investments and can result in the loss of tax-deferred status for the entire IRA. This includes using an IRA as security to obtain a loan, using IRA funds to purchase personal property, or paying yourself an unreasonable compensation for managing your own self-directed IRA. Executing a prohibited transaction can result in the entire IRA being treated as a taxable distribution to you.

Like fund holdings, ETFs, and other investments, it’s critical to understand exactly what you own and how to deal with the tax liabilities.

Reference: Fox Business (March 6, 2019) “Your IRA and taxes: Don't get a surprise tax bill”

Holden & Campbell, LLC – Annapolis Estate Planning

What Happens When There’s No Prenup for Billionaires? - Annapolis Estate Planning

How do you divide a nearly trillion-dollar empire when a divorce occurs and the CEO doesn’t have a prenup? Investors are wondering and watching to see.

With a 16% stake in the Amazon, how will founder Jeff Bezos’ divorce impact the company? There’s no prenup in place, and since MacKenzie Bezos has been his wife for the entire ride, from online bookseller to global force, she can anticipate receiving half of the community property. That’s according to Wealth Advisor in the recent article, “Amazon Achilles Heel: Bezos Prenup Disaster Threatens $800B Behemoth.”

That may be a challenge, when the majority of that wealth is in his $126 billion in stock. Jeff can give her close to 40 million shares and a few of their houses and call it good, but there can be problems with that arrangement, too.

MacKenzie could get half the stock in exchange for giving up the voting rights and the right to sell. This would effectively lock her in as a silent partner, shoring up Jeff’s continued control. Amazon could give her a prestigious but non-executive role on the board. She would certainly be a candidate to serve as director, with her 8% of the stock.

MacKenzie needs a way to liquidate whatever shares she gets, because Amazon doesn’t pay dividends and is unlikely to do so for the foreseeable future.

There’s no simple way to turn that asset into current cash flow, short of selling some stock. In fact, that’s what Jeff does now: he’s been selling a bit of his to fund other investments and the family lifestyle, in addition to paving the way for philanthropic ventures.

MacKenzie will need the same authority in her divorce settlement, or she’s still going to need cash.  At some point, a judge may allow her to sell $60 billion in stock.

The goal now is making sure that Jeff keeps control of the company. That should have been the plan years ago. Amazon doesn’t have a real succession plan. There’s no trust holding the stock safe for future generations. And the company doesn’t even carry life insurance on him. As a result, they are all subject to his mortal frailty. Divorce hit before death or disease, but it was only a matter of time.

Jeff has done the same thing that many business owners do. The scale is different but the lack of succession planning for the loss of a key person is the same.

Reference: Wealth Advisor (January 14, 2019) “Amazon Achilles Heel: Bezos Prenup Disaster Threatens $800B Behemoth”

Holden & Campbell, LLC – Annapolis Estate Planning

How Budgets Work for Businesses – Annapolis Estate Planning

You are so good at what you do that you recently launched a new business. Maybe it’s your retirement dream business? If your skills at bookkeeping and budgeting are nowhere near as good as your new business skill, spend some time learning how to create a business budget.

The first rule of any budget, whether for your home or a new business, is to estimate and match your expenses to revenue. You’ll need to know how much you need to earn to keep your operation going, and what numbers will indicate that it’s time to expand. Without a budget based on real numbers, and not just wishes, says Investopedia in the article “6 steps to a better business budget,” there’s no way to know whether you are succeeding or losing ground.

Every business owner will have a somewhat different process, situation or way of budgeting. However, every business owner should consider the mortgage, utility bills, payroll expenses, cost of goods sold, expenses (raw materials), interest, tax payments, and any other costs specifically associated with the business when setting up or taking over an existing business.

A business that’s already up and running can make assumptions of future revenue based on recent trends in the business. If it’s a startup, you'll have to make assumptions based on your geographic area, hours of operation and research of other local businesses.

After you have this information, you should then match the business's revenue with expenses. Calculate what an average weekly expense would be for overhead, utilities, labor, raw materials, etc. Based on this information, you may then be able to estimate whether you'll have enough extra money to expand the business, or to save. Similarly, owners may see that to have three employees instead of two, they’ll have to generate more in revenue each week.

Use these six tips to help you put together a small business budget:

1. Industry Standards. Conduct some research for data about the industry, speak with local business owners, visit the local library, and look at the IRS web site to get an idea of what percentage of the revenue coming in will likely be allocated toward cost groupings. Small businesses can be extremely volatile, since they are more susceptible to industry downturns than larger, more diversified competitors.
2. Create a Spreadsheet. Prior to buying or opening a business, make a spreadsheet to estimate what total dollar amount and percentage of your revenue will need to be allocated toward raw materials and other costs. Talk with any suppliers you'd have to work with before you continue. Do the same thing for rent, taxes, insurance, etc.
3. Add in Some Breathing Room. While you may estimate that the business will generate a certain rate of revenue growth going forward or that certain expenses will be fixed or can be controlled, these are never set in stone. Factor in some slack and make certain that you have more than enough money saved or coming in, prior to expansion or adding new employees.
4. Cost-cutting. Review items that can largely be controlled. You should also wait to make purchases until the start of a new billing cycle, or take full advantage of payment terms offered by suppliers and creditors. A little maneuvering could give a business owner some much needed breathing and expansion room.
5. Review the Business. Although many firms draft an annual budget, small business owners should do so this more often. It’s not uncommon for small business owners to plan only a month or two ahead, because business can be quite volatile and unexpected expenses can ruin revenue assumptions.
6. Keep an Eye Out for Less Expensive Services and Suppliers. Don't be afraid to shop around for new suppliers or to save money on other services being used by your business.

You might hear business owners using different phrases to describe their budgeting, including matching revenues and forecasting. The basic concept is similar to a household budget in that you want to know what’s coming in, what’s going out (and where’s it going), if enough funds are coming in to cover your costs and if there’s enough to pay yourself. Just like at home, you’ll benefit from having an emergency fund to help you through the invariable ups and downs of growing a new business.

Reference: Investopedia (June 26, 2018) “6 steps to a better business budget”

Holden & Campbell, LLC – Annapolis Estate Planning

Expect to Keep Working? You Still Need a Succession Plan – Annapolis Estate Planning

If you’re a business owner who loves what you do, you consider your business to be one of your biggest achievements after your family and enjoy the challenges it presents. As for retiring, why should you?

Some business owners are reluctant to even consider selling the business or retiring. They don’t make a succession plan, says The San Antonio Business Journal in the article, “Plan your exit even if you never plan to leave your business,” and that can lead to a disaster for their family and their employees. That’s something the business owner needs to consider—and why even if they plan on working, until they are carried out, they need a succession plan.

Decrease your taxes. Whether you ultimately decide to sell your business, transfer ownership or die working, you probably don't want to pay more taxes than you have to. There are two ways exit planning can help minimize taxes, even if you truly want to work until you die. If your business value increases, your estate can benefit from a step-up in basis, if your ownership transfers pursuant to your estate plan. This saves your estate or beneficiaries from paying duplicate taxes on the entire business value.

The lifetime exclusion for gift and estate taxes is now to the point where most small and mid-sized business owners don’t need to pay estate taxes, if owners have created an appropriate estate plan. Your exit plan lets you leverage these benefits, since estate planning is a vital component in proper exit planning.

Protect your values. If you created a work culture that’s so unique and strong that it helps your company stand out in the marketplace or your business gives back to the community through charity work, exit planning lets you pursue and preserve your progress toward those objectives. Exit planning strategies can foster the culture you’ve built, protect the employees who made the business a success, and help you build the legacy you want. Exit planning can help keep your chosen values front and center and protect its value, even without your presence.

Growing your business. Everyone wants their business to grow in value, but many business owners get to a point where they can’t grow the company any more, by simply doing the same things they’ve been doing. However, exit planning concentrates on building business value, whether you exit or not. These activities can help you increase your business’ growth potential, by emphasizing value drivers. Those are the aspects of your business that make it attractive to buyers. When it’s done the right way, installing value drivers can make your ownership even more fulfilling—concentrating on certain value drivers can let you focus on only your favorite tasks within the business and delegate your least favorite responsibilities to other qualified employees.

You may keep working until the very end, or you may encounter a life event that makes you rethink how much of your time you want to devote to the business. Either way, a succession plan is like an estate plan for your business. It protects your family at home and your work family. Both will appreciate you doing so.

Speak with an estate planning attorney who can help you with your personal and business plans for the future.

Reference: The San Antonio Business Journal (October 16, 2018) “Plan your exit even if you never plan to leave your business”

Holden & Campbell, LLC – Annapolis Estate Planning

Can an Estate Plan Become a Legacy Plan? - Annapolis Estate Planning

The old saying that the first generation builds the business, the second generation struggles to maintain it and the third squanders everything, is sadly, statistically true. However, creating a legacy might give you better odds of success.

If you’ve been responsible and had an estate plan created, you are way ahead of most of your peers. You’ve planned for your family and your heirs with a will, powers of attorney, an advanced directive and likely created the appropriate trusts to hold life insurance policies to minimize estate taxes and protect the proceeds from creditors. You may have even done some succession planning, using family trusts and other planning vehicles. However, will this be enough for a lasting legacy?

Forbes’ recent article, “How To Turn Your Estate Plan Into A Legacy Plan,” says that perhaps you’ve heard that legacy planning is the solution to your problem. However, you are worried about the expense. If you create a legacy plan, does it mean you’ve wasted time and money? No, it doesn’t. The documents you’ve already prepared for estate planning can most likely be used and incorporated into a more effective legacy plan. Let’s look at how to turn an estate plan into a legacy plan.

Form A Legacy Team. This effort takes a team. You need a team of professional advisors working together to move you towards success. A legacy team will typically begin with three main areas of expertise: legal (estate planning attorney), tax (accountant) and wealth/financial planning (wealth advisor). From there, the legacy team may expand, based on your needs and circumstances. Your team’s makeup will depend on you and your family’s specific needs and circumstances.

Get A Legacy Mindset. Think “process” versus “plan.” Traditional estate planning is often seen as complete, once estate planning documents have been prepared and signed. However, the reality is that after you’ve created legal entities and a structure for your estate and/or legacy, you’re just at the start of the process. The legacy plan is a recipe for your success and the framework through which your legacy is going to thrive and grow.

Educate Yourself on What You’ve Already Created. With your legacy team in place and with your legacy mindset, understand what your existing estate plan does and doesn’t do. Review your estate plan and determine if it distinguishes between legacy and non-legacy assets (which almost always should be handled differently on your death). You also need to plan for your life and how to build the legacy you ultimately want to leave behind through specific assets in your estate.

Put the Plan into Action. Creating the plan is the first step, the second is implementing the plan. That will ensure that your legacy will continue, ideally for generations to come.

Reference: Forbes (August 22, 2018) “How To Turn Your Estate Plan Into A Legacy Plan”

Holden & Campbell, LLC – Annapolis Estate Planning

What Happens to a Business When the Owner Retires? - Annapolis Estate Planning

It takes time to build a business, and it can take just as long to create a strong succession plan.

Many business owners can’t imagine a life without the business they built, so they often postpone planning for their own retirement and the sale or transfer of the business. That doesn’t work out well.

There are steps to take when business owners decide to actively engage in planning for their business to continue to thrive after they step down. This article from Forbes, “Eight Factors To Consider Before Retiring From Your Business,” offers some useful tips.

1. Plan Ahead. A good plan is to prepare, in this case, years in advance. Pinpoint the major areas that could hamper the sale.
2. Identify A Successor. Have a detailed succession plan in place. Identifying your successor(s) early in the process will allow you time to gradually place them in their new responsibilities and give them the benefit of your wisdom and experience.
3. Make the Business Work for You. If your business would break down the second you step away, you’re working for your business rather than your business working for you. The time to think about your exit strategy, is when you start your business, not when you’re ready to exit.
4. Prepare an Exit Plan. Because most owners depend on their businesses for income, a lack of planning could put their main source of income at risk. It’s critical for a business owner to meet with her legal and financial team to decide on the best exit strategy. Learn your options and make an informed—rather than an emotional—decision.
5. Keep Working After the Exit. Stay on for a few years through the exit to let your buyer have some time to transition and structure better buyout terms for you, as you help them grow through the transition.
6. Make Sure the Systems and Processes are Solid. With processes and systems in place, a leadership change will be more likely to proceed smoothly. Any business that is successful should have these in place anyway: best practices, key performance indicators, job and responsibility descriptions and an organizational chart. Clarity for employees and managers is crucial for a transition.
7. Delegate Responsibilities. Confirm that all logistical areas are covered, and that there are backup plans in place. Make sure the person who will be leading the business, is focused on maintaining the corporate culture during the transition.
8. Instill Your Values During the Transfer Process. If the transfer is planned well in advance, responsibilities and value systems can be transferred to the new owners and managers. Some owners decide to maintain some shares in the business, so that they can keep an eye on—and have a say in—how the transition is taking place.

Reference: Forbes (August 27, 2018) “Eight Factors To Consider Before Retiring From Your Business”

Holden & Campbell, LLC – Annapolis Estate Planning

No Succession Plan Often Means Businesses Live and Die with Owners - Annapolis Estate Planning

To make it past the first generation, family owned businesses need a lot of communication and planning for succession.

The challenge is clear: less than a third of all family owned businesses will survive to the second generation. By the third generation, prospects for survival are even worse—only one in 10 will make it. With approximately 80-90% of American businesses being owned by families, the potential for business longevity is not great.  However, it can be addressed.

KRCU’s recent article, “Business Succession Planning is Very Important,” reminds us that business succession planning is a process in which business owners research and consider a strategy to move forward in the event of death, illness, or simply transition.

Business succession planning implements several estate planning strategies. There is no “one size fits all” plan. A business owner should carefully consider his or her options. Without a plan in place, there’s a good chance for failure.

There are several factors to be examined. There are questions like estate taxes, liquidity, ownership percentages, family disagreements and the management capabilities of those relevant individuals.

The uncertainty of a transition can impact the business internally among staff and externally with customers. As a result, it’s vitally important to create a business succession plan and communicate that plan to your team and family.

There are many succession planning vehicles and succession planning concerns. Seek the advice of an expert on these matters and do it sooner rather than later. Work with an experienced estate planning attorney, who can walk you through the issues that must be addressed.

Many experts think that business succession planning is at least as important (and maybe more important) than individual estate planning.

Improving the chances that a family owned business will continue past the first generation, takes as much work as building it did in the first place. A seamless transition to the next generation is a worthwhile task, benefiting customers, employees and the community, as well as family members.

Reference: KRCU (June 17, 2018) “Business Succession Planning is Very Important”

Holden & Campbell, LLC – Annapolis Estate Planning

Business-Owning Baby Boomers Need to Start Succession Planning – Annapolis Estate Planning

With an estimated 10,000 Boomers retiring every day, members of this generation who own businesses should already have their succession plans in place.

Exit or succession planning is a lot more complicated than most business recognize. It takes a long time if it is to be done properly. A recent article from Moultrie News, “Securing retirement through engaging in business exit planning,” says that not all business-owning baby boomers are ready.

Many soon-to-be retirees are closely-held business owners who have created and operated very successful businesses for years, but they’re now considering what their next move will be.

These people frequently have questions about transferring their interests to their children, key employees, or even selling to an outside third-party. They wonder what the company is worth and if they’ll be able to achieve financial independence. Another big issue is how to create a plan that keeps them in control and provides greater options.

Because the vast preponderance of closely-held business owners’ net worth (up to 85%) is wrapped up in their businesses, it’s vital that they start the exit planning process early.

Starting early, lets an owner consider and address critical planning needs.

Every successful exit begins with deciding when the owner wants to exit, to whom they wish to sell or transfer their business and how much equity they want or need from the business.

Your exit plan should address both personal and business asset protection, strategies for tax minimization and value maximization, successor development, business continuity planning, and estate planning.

Your exit plan is your blueprint that keeps you in control of the exit planning process.

Baby Boomers should carefully consider and integrate this into a comprehensive, tailored plan.

When business owners map out a plan for their business early on, they gain more options for the business and for their own retirement. It’s a win-win for the owner, their family and the business.

Reference: Moultrie News (March 30, 2018) “Securing retirement through engaging in business exit planning”

Holden & Campbell, LLC – Annapolis Estate Planning Attorneys

Estate and Inheritance Taxes: How Do They Impact Entrepreneurs? - Annapolis Estate Planning

Does having to pay an inheritance tax discourage someone who might have built an empire, from doing so? Or does an estate tax make a business owner retire earlier?

Forbes recently provided an analysis of a research paper examining the impact of estate, wealth transfer taxes and other inheritance taxes on entrepreneurs and those considering starting a business in “How Do Estate And Inheritance Taxes Affect Entrepreneurs?” Do entrepreneurs spend a lot of time worrying about the impact of federal estate tax on their life’s work? Does reducing the number of taxpayers who will need to pay federal estate taxes, which recently occurred, mean an increase in new start-ups? The answers are not that simple.

The research shows two primary effects of wealth transfer taxes. One, by reducing the size of after-tax bequests, it makes heirs less likely to start or maintain a business. Two, the prospect of future estate or inheritance taxes appears to speed up a business owner’s retirement date, but also discourages labor force participation for wage earners. This indicates that there’s no simple way to characterize the effect of the estate tax on entrepreneurship.

The estate tax might impact the decision to start a business or keep it going, if business owners are looking ahead and want to leave the company to their heirs. However, the evidence on this is surprisingly ambiguous.

For example, most wealthy people don’t take full advantage of opportunities to transfer limited amounts of wealth through tax-free gifts during their lifetimes, which is a very basic tax avoidance strategy. The estate tax also impacts heirs by decreasing the size of after-tax bequests.

The current federal estate tax applies to a fairly exclusive class with a generous exemption from the unified estate and gift tax—$11.2 million for singles and double that amount for couples. Many deductions reduce the amount of wealth subject to the tax, including unlimited deductions for charitable donations transfers to spouses and “valuation discounts” that reduce the amount of family-owned business and farm assets that are subject to the estate tax.  However, anything over the exclusion limit and deductions is taxed at 40%.

The research finds that receipt of an inheritance raises the likelihood of having active business income by about 13%. The size of the inheritance is also a major factor but is usually less important than the fact that an inheritance exists. In addition, the thought of future estate taxation reduces the likelihood of remaining self-employed, but not because people elect wage employment over self-employment.  It is actually because it makes employment less attractive. Taxing bequests reduces the payoff to working (and saving) for those with bequest motives, which makes both self-employed people and wage earners slightly more likely to retire.

Therefore, the research shows that the impact of wealth transfer taxes on entrepreneurship appear to be small.  However, the researchers point out that there are several important caveats to their conclusions. One is that self-employment is not the same as entrepreneurship, and most survey data can’t distinguish between entrepreneurs who innovate and take risks, from business owners who don’t.

There are other factors that must be considered before any real conclusions can be made. If your parents or grandparents were successful business owners, you would be more likely to consider starting a business than someone whose parents were employees. You might also have the option of entering the family business, which children of employees do not have.

It is not clear that estate and inheritance taxes are any more burdensome than any other taxes. Regardless of your economic bracket, an appointment with an estate planning attorney to review your tax liability under the new tax law should be on your to-do list for the first part of 2018.

Reference: Forbes (March 7, 2018) “How Do Estate And Inheritance Taxes Affect Entrepreneurs?”

Holden & Campbell, LLC – Annapolis Estate Planning Attorneys

Best Time to Start on a Succession Plan? The Day You Start Your Business - Annapolis Estate Planning

It may sound whimsical, but the moment you open a business is also the time to start thinking about how you’ll exit the business, whether you intend to sell to a partner, leave the entire business to a family member or sell as soon as you come up with the next big idea.

One of the biggest mistakes made by entrepreneurs is failing to create a written plan for their long-term exit strategy. What they don’t understand is that by creating a succession plan, which includes ways to boost the value of the business years before you want to sell or retire, they’ll have a created a road map for a more successful business.

Springfield (MO) Business Journal’s recent article, “Starting a business? Plan your exit now,” advises that you begin with creating a culture of success with your employees, especially the key people. That means fostering an ownership mentality, so they see their critical role in the company’s long-term success and their role in helping that to continue in the future, long and short term.

One of the first steps is to identify who will take over, whether that’s a partner, family member, employee or a purchaser from the outside. For death-of-owner planning, you should draft a buy-sell agreement with an experienced attorney. A buy-sell agreement will include a purchase price formula. That formula needs to be revisited as conditions change.

 The next step is to decide how the buy-sell agreement will be funded. A common option is life insurance. The business owner is the insured, and the successor-owner is the beneficiary. This policy can provide necessary and immediate cash for the successor-owner to purchase the business from a surviving spouse.

If you want an employee or family member to take control at your retirement or death, start with their training and/or experience now in order to get them adequately prepared. You may also consider “stay-put” agreements to keep key managers and employees around to help with the transition to new ownership. You may want to consider a “stay bonus”, in addition to regular pay as an incentive.

Every “death-of-owner” planning scenario also applies to exit plans from the sale of the business. Here are five other contingency planning items:

1. Disability, illness or injury of the owner. With disability/income replacement insurance for the owner, think about business overhead expense insurance. That insurance helps make sure the bills are paid and the doors stay open while you’re out.
2. Death or disability of a key employee. Consider the expense of replacing a top manager or salesperson temporarily or permanently. What revenue would potentially be lost during the transition? Look into key-person life insurance and/or key-person disability insurance.
3. Resignation of a key employee. With an executive bonus plan, a “golden handcuff” can help. One way is to contribute to a cash-value life insurance policy on behalf of the employee. The life insurance component gives the employee’s family important financial protection if she dies, and the cash value can supplement retirement savings one day, if she does not die. This will let the employee see how much she means to the business. Vesting terms in a written agreement will also make the program even stronger, because if she departs before the vesting period is complete, she’ll lose some or all the benefits.
4. Commercial property and casualty insurance. These policies can include business continuation provisions to cover expenses and payroll during any downtime after a catastrophe.
5. Estate planning. Review your estate plan with your estate planning attorney, with a dual focus: your business and your family’s best interests. Your plan must address estate tax and gift tax issues. It should include your will, powers of attorney and other estate planning documents.

Avoid the hazards that occur for so many business owners because they fail to plan for the future. Doing so early on, will allow your business to flourish long after you have moved on.

Reference: Springfield (MO) Business Journal (October 2, 2017) “Starting a business? Plan your exit now”

Holden & Campbell - Annapolis Estate Planning Attorneys

Holden & Campbell - Annapolis Estate Planning Attorneys