Ryan Barradas is scheduled to speak at the CFO Playbook West for Private Companies confernce being held in San Francisco, CA. Succession planning and the CFO
Happy New Year. We begin this year as we ended the last – approaching another cliff. To start the year off right, Andy Friedman appeared yesterday on CNBC to discuss the ramifications of the fiscal cliff compromise. You may access the segment by clicking here.
As we wish you and your family a Happy New Year we’d like to provide you with some insight into the most recent tax legislation affecting your family and business. Congress passed the American Taxpayer Relief Act early Tuesday morning enacting tax hikes to the wealthiest Americans while extending other pro-business tax incentives. The act’s nontax features include extensions of the emergency unemployment insurance and postponement in automatic cuts in Medicare payments to physicians. It also delays until March automatic federal sequestration that otherwise would have begun this month.
Individual Tax Features
All the individual “Bush era” tax rates are retained with the addition of a new top rate of 39.6% imposed on income over $450,000 for married taxpayers filing jointly. Personal exemption and itemized deduction phase-outs are reinstated at a higher threshold of $300,000 for married taxpayers filing jointly. The capital gains and dividend rate has increased to 20% for those taxpayers in the top bracket and remains at 15% for the middle brackets and zero for taxpayers in the 10% and 15% brackets. In addition, the law permanently indexes the Alternative Minimum Tax exemption amount for inflation, extinguishing the need for the annual “patching” of the AMT.
The American Opportunity Tax Credit for qualified college tuition expense was extended through 2018, and the above-the-line deduction for qualified tuition was extended through 2013. The Act also extends tax-free distributions from IRA’s to charitable organizations through 2013.
Gift and Estate Tax Features
The estate and gift tax exclusion amount remains unified at $5 million indexed for inflation but the top rate increases from 35% to 40% effective January 1, 2013. Also, the “portability” election, allowing the surviving spouse to utilize the deceased spouse’s unused exemption, has been made permanent.
Business Tax Features
Enhanced depreciation incentives have been extended through 2013 including increased expensing under Section 179 and additional 50% first-year bonus depreciation. Also the fifteen-year straight-line cost recovery for qualified leasehold improvements has been extended.
The Act temporarily extends the 100% exclusion of gain on Qualified Small Business Stock held for more than five years. In addition, it extends the reduction in S corporation recognition period from 10 years to 5 years for built-in gains tax.
The credit for increasing research and development activities has been slightly modified and extended through 2013.
Healthcare Reform Legislation
In addition to the various provisions discussed above certain provisions from the Healthcare Reform Legislation took effect January 1. The employee portion of the Medicare tax, normally 1.45% of covered wages, increased by 0.9% on wages exceeding $250,000 for married taxpayers filing jointly. An additional Medicare tax on investment income also took effect January 1. The Legislation imposes a tax on individuals with modified adjusted gross income greater than $250,000 for married taxpayers filing jointly. The 3.8% tax is on the lesser of the taxpayer’s net investment income or the excess of the taxpayer’s modified adjusted gross income in excess of $250,000 for married taxpayers filing jointly. Net investment income includes interest, dividends, annuities, royalties, rents, capital gain and passive activity trade or business income.
As always should you have a client matter you would like our assistance with, please feel free to contact us.
The WealthPoint Team
For hundreds of years, affluent families have been guided by their advisors to steward their material assets. Attorneys, CPAs, investment and insurance advisors and financial planners all come to the table to help you identify the best course of action. The stewarding of your financial or material assets is actually only one-third of the process. The two additional elements are beginning to surface in more conference rooms and family rooms than ever before.
The second and third elements of planning include 2. the communication of your decisions to those who’ll be impacted by them, and 3. The quality of communication that exists within the family system in general. When all three areas have been tended to, families achieve holistically wealthy relationships.
Why is open communication with heirs important?
So many times we see families concerned that if their heirs knew of their substantial impending inheritance, it would rob them of drive and work ethic and implant a sense of entitlement that derails their adult life.
In reality, there are many programs and models available for mentoring heirs to be effective wealth owners. By beginning the process while you’re here to participate, you can observe and influence the training process. You can help ensure that the inheritance doesn’t derail the heirs and that the financial resources are used for great causes, not squandered. You can leave this world knowing that your heirs understood who you were, how you amassed the wealth and what you hope will happen with it in the future. That’s why communicating the nature of your decisions is so crucial to establishing wealthy relationships.
Quality of communication: not just what but how…
The third element of wealthy relationships is the quality of communication that exists or can be aspired to within your family system. Just like in marriage, the better the foundation for communication, the greater the likelihood that relationships can survive difficult times. This is a crucial and wonderful area that can be addressed during your lifetime regardless of the age of your heirs. Even relationships with and between adult children can be repaired and strengthened. Again there are entire processes and advisory disciplines based on the improvement of family communication.
Picture your heirs thirty years from now sitting around a family dinner table. What do you aspire for in the future of those sibling relationships and developing family units? Consider your ability to influence what’s happening at that family dinner simply by doing the heavy lifting to increase the quality of communication in your family today – to equip them with communication skills just as you’ve equipped them with morals, values and integrity. This is the third element of wealthy relationships.
If these aspects of planning appeal to you, ask your advisors how to bring the process and conversations to the proverbial planning table. And with the holidays approaching, there’s no better time for families to rally around their long term goals and commitments to each other.
In our adult lives, we’re often naturally inclined toward philanthropy. Whether we give our time, talent or financial resources, doing so is a response to feeling grateful for our own good fortune. Many who have succeeded in business and career feel that much has been given to them to make their success possible – mentorship, training, education and opportunity. We find ourselves wanting to give back – applying gratitude to restore the equilibrium.
How do we teach and imbue the philanthropic cycle with young people who have yet to complete their first decade of life? Creating practices and awareness around gratitude is a place to start.
Embracing non-financial philanthropy
You can begin the process by sitting down with a grandchild, niece or nephew and discussing the aspects of life that make him or her feel safe or happy. Record the young person’s thoughts in a dedicated notebook that you’ll come back to for future parts of this adventure. After you’ve created an initial list together, ask the young person to specifically consider things that can’t be held in two hands – intangible things that make him or her feel safe or happy. This might include playing outdoors, laughing with friends or learning new things in school.
Through the course of your conversation, help the young person understand that to “have” isn’t limited to physical possessions. When you become aware of what you have that doesn’t cost anything, there can be an unlimited supply to give away.
Creating contrast: take an observation field trip
With your notebook in hand, take the young person out and about into the community. Visit a mall or a playground, a soup kitchen or a hospital. Select an environment that will stretch his or her thinking without being overwhelming or scary. Ask the person to notice what the people around them have and what they don’t have. Ask them to consider things that are intangible – that they can’t hold in their hands. This could be a special talent on the playground, a beautiful smile or an inclination to share.
Anchor the experience with gratitude
Consider creating a regular connection time to continue discussing what the young person noticed in his or her life and the lives of others. Help the young person understand the connection between being happy about your circumstances and being thankful. Awareness of gratitude takes people to that adult response of wanting to give – to restore equilibrium for all we’ve received.
Overtime you can transition your discussions to help the young person identify behaviors he or she would like to donate and to whom he or she wishes to donate. This could be as simple as giving a special smile to a kid at school, or as involved as going back to the soup kitchen to play games with or serve soup to the people in the room. Throughout your interactions remember to pause and be grateful for the experiences.
Most successful people have planned for the future of their financial resources through the use of investments, insurance and legal documents. Fewer have tended to the non-financial aspects of planning for the future of family, reputation and contribution.
The topic of wealth has many stigmas in today’s society and as such, families of substantial resources often struggle with discussing big issues surrounding money. As a result, related topics of non-financial planning are less likely to be a part of the family’s conversations. However, it is possible to decouple the conversations and begin talking about the non-financial aspects of your family’s future before or without discussing dollars and distribution plans.
Begin with a discussion around goals and aspirations
Non-financial planning can address several key layers of self and family. We recommend beginning with one area and creating a structure or an opportunity to begin thinking about and documenting your goals and aspirations. Start with an area that feels highly accessible. For some, it’s easiest to work through your goals for yourself first. Others find that an upcoming family vacation or dinner offers a great forum for a group discussion.
Here are some areas to consider:
› Yourself (entrepreneur, career person, contributor outside of work)
› You and your spouse
› The family system, including your children and grandchildren
› Future outgrowth of your family system – your children’s grandchildren, etc.
› Philanthropy for the family as a whole, currently and into the future
Here are some questions that can stimulate your thinking:
› What would you like to see happen?
› What would you like to be known for or remembered for?
› What impact would you like to have?
› What values or behaviors would you like to see embraced?
If you begin with a group discussion, consider ways to jump start everyone’s thinking. Scan the newspaper for causes about which you’re passionate. Ask everyone to write down the relationships, activities or values that are most important to them. Then branch out into the questions noted above.
In order for individuals and families to maximize their impact and contributions, non-financial planning must be seamlessly integrated with a family’s financial resources. Only then can the family’s goals and aspirations guide the structure, planning and long-term use of their material resources.
When owners begin to be proactive regarding succession and exit planning or as we call it, business retirement planning, there is one main question that needs to be answered.
“When will I move from I need more to I have enough?”
Both the question and the answers are as complex as they are varied.
For owners to move into the decision making process for their eventual exit, they must clearly understand and identify these three areas of financial need:
- Core capital – Amount necessary to maintain financial independence throughout life expectancy
- Risk capital – Amount available to subject to future risk
- Emergency capital – Emergency cash for unforeseen expenses (health care, etc.)
It is impossible to implement great planning strategies and move forward in the process until the question of “do I have enough?” is answered.
Traditional financial planning comes up woefully short as most financial planners simply accept the value placed on the business as the exact amount that the owner will receive upon retirement. What if this asset is never monetized?
Business owners crave the ability to see their financial life in an integrated and coordinated manner. They need their personal finances detailed in much the same way they organize their comprehensive business financials. From there the “what if” scenarios can be applied and forecasted out to see if their definition of “enough” is a reality 20-40 years into the future.
When the question of “When will I move from I need more to I have enough?” is accurately answered, business owners gain the confidence to make the big decisions that will positively impact their exit, succession or estate planning.
One of the most important estate planning decisions is that of selecting a trustee or executor. The choice can be a game changer for how your heirs live with and execute your decisions. However, too often the selection is made without the benefit of talking through the potential pitfalls or consequences.
Common pitfalls to avoid
Many families select the oldest adult child as their power of attorney during life and trustee and executor at death. While a strong family bond may exist with first-born children, it doesn’t automatically make them the best fit. It’s important to consider their adult history with regards to decision making. How do they handle their own medical and financial life? How do they behave in business or with family obligations? Do they have a track record of making consistent decisions and being accountable?
What to look for in a trustee
The person should have the affinity, desire and experience to step into the role. They’ll need the capacity or training to understand complex legal, financial and investment situations. Alternatively, they need to be able to discern who to hire for help and when. This includes having a track record of making sound financial decisions and generally being well organized with their own affairs. Ideally, your trustee will have the capacity to think like you and make judgment calls in the manner you would for yourself. They should be aligned with your value system and able to objectively make decisions from your vantage point; as if standing in your shoes.
Sustaining relationships requires eliminating surprises
A family trustee can easily become doused in negativity from other family members. It’s crucial to consider whether the selected person can handle conflict, and truly wants the role. Ideally, it’s best to eliminate the element of surprise for everyone involved by communicating your plans in advance. On the medical side, this involves documenting and communicating your Advanced Directives – specific decision making guidelines to follow should you be unable to make decisions for yourself.
With regards to the role of trustee and executor, all family members should understand not only your choices, but the reason you made the choices. They should understand the context for your estate decisions – hearing it directly from you so they can air their questions and listen to your thinking. The family member(s) chosen for leadership roles should understand why they were selected. Likewise, siblings or other heirs should understand this too. That way, you can set the stage for the selected individual(s) to succeed in their leadership role(s).
Beyond the legalities
Finally, it is important to transition all of your decisions in context of your vision for the use of your wealth. Develop a Family Mission Statement and share it with all heirs. Ensure they understand your philosophy and expectations for the family wealth going forward. Ensure they receive the training they need to be effective stewards of both your vision and your financial resources.
It does not matter where in the world a family business is located, according to Deniel Banks of DW Banks Company, Inc, one thing all family business leaders have in common is that they want easy-to-use tools to help with succession planning.
As a result of seeing this trend around the world, Banks developed a checklist as a meaningful way to stimulate business leaders thinking and starting important conversations with family members. He says the checklist has an international perspective integrated in.
“Ten Principles for Family-Owned Business”
- Make dreams a reality – What are your own dreams? Your family’s dreams? You customer’s dreams? Answer these questions and align these dreams with business and family strategies.
- State principles and goals clearly and allow your children to develop their own goals for personal happiness and success regardless of whether they end up in the family business or not.
- Distribute leadership, empower others, and offer mentoring and coaching when necessary.
- Follow criticism with encouragement. Be ready to apologize.
- Lead the family by example. Apply some of what you do best at the office while at home.
- Know yourself. Be clear on your leadership strengths, your beliefs, and your values.
- Encourage your next generation family members to take action and do what’s right. Be persistent in communicating ideas and listening to theirs.
- Respect and honor differences. Learn from other cultures and create an environment the embraces the diversity in people and ideas.
- Collaborate by moving from “position power” and hierarchy to building “relationship power” locally and globally.
- Foster a broad perspective and give something back.
Banks said he likes to ask his clients to circle three of the ten items that they want to focus on most in their own business to move towards 21st century leadership and a global perspective.
Corporate structure is an important conversation to have when creating your succession objectives. The type of corporation has a major impact on your transition. Are you going to sell to a public company? Are you going to go public? Who are your potential owners or future owners? Are you going to keep your company in the family? How many owners are there going to possibly be? The answer to all these questions would encourage one corporate form over the other.
In 80% of our consulting cases, some change of corporate structure occurs. Usually we see a corporation set up at inception with little thought to the long term objectives. As a result, a change often occurs as the business becomes significant. So what are the key differences? And which of those factors is most important to you and your company? Follow the link below for a very basic overview of C-Corps vs. S-Corps vs. LLCs.