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Succession Planning Workshops

Monday, January 16, 2017 @ 11:01 AM
Author: Peter Brehm

SCORE-Workshop-Succession Planning Series flyer

Together with SCORE and Northeast Bank, on March 2, 2017, and March 16, 2017, Business Law Center will be hosting two seminars geared towards helping small business owners protect their business, and improve the value of their business.

In Session 1, Succession Planning – Preparing to Leave Your Business, you will learn:

• Why should I have a plan?
• What happens to my business when I die?
• What happens if my partner dies, gets disabled, or divorced?
• How to get my business ready to sell?
• Could I sell my business now? And retire?
• How do I protect my family?
• How do I minimize taxes?

In Session 2, What’s Your Business Worth? you will learn:

• How can I determine the value of my business?
• What is the value of my goodwill?
• How do I decide how much insurance I need?
• What are my partners’ shares worth?
• Can I buy them out?
• Can my employees afford to buy me out?

For more information, and to register, you can go to SCORE’s website HERE or you can contact our office.

Peter Brehm

952-943-3904

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Preparing Your Business for Sale

Thursday, January 12, 2017 @ 10:01 AM
Author: Peter Brehm

I have been working with small businesses for nearly 20 years, and I can’t say how often I have seen sellers leave money on the table because they hadn’t prepared their business for sale.  People buying small businesses are usually looking to buy a job, and are seeking confidence that they can make your business work for them.  The more turn-key the business, the better it will be for the buyer.  Which is why franchises are so successful. 

If you think you will be selling your business one day (and you probably will), here are some basic steps you can take to help make your business easier to sell, and make it more valuable.

1.      Eliminate the Black Box.  Obviously, buyers want to know if your business is making money, but presenting a potential buyer with historic EBITDA, revenue, or cash flow numbers is not enough. Buyers aren’t buying your profits from last year, they are buying the profits they might earn in the future.  If they don’t feel confident that they will be able to replicate what you earned, they will pay less for your business.  Be prepared to explain not just what your business made, but exactly how sales, marketing, equipment, suppliers, customers, intellectual property, and labor contributed to your profits.  You are, after all, the world’s foremost expert on your business, and should be able to explain how it runs in detail.  When buyers can see how your business makes money, they will be more confident that they can make money too. 

2.      Eliminate You from Your Business.  Think about your business as a money printing engine.  If a buyer purchased that engine, would it run efficiently without you, or are you the only one that knows how to prime it, or where the throttle is?  As a small business owner, of course you are vital to your business, but you must take steps demonstrating to a potential buyer that the engine will run efficiently without you.  Help you buyer visualize your business without you.  Identify key employees, and start delegating responsibilities to those people.  Prepare a transition plan that explains how you will help train and mentor your buyer in your business.  Communicate to your buyer exactly how he will be able to retain your key customers, vendors, and employees. 

3.      Clean up Your Books I.  When you own a small business, and there is enough money coming in to cover your expenses and pay expected profits, there is little incentive to keep great looking books.  But your profit and loss statement (P&L) and balance sheet say a lot about your business, and speak volumes about your attention to detail.  When a client presents me with financial statements prepared by a professional accounting firm, my confidence in those numbers goes up.  If all they have are tax returns, or some hastily assembled P&L, my confidence goes down, and I will generally advise my client to either walk away, or make some ridiculously low offer.  With the advent of QuickBooks, and other online accounting packages, there is simply no good reason why you should have bad books.  Hire a good bookkeeper or accountant, and get your books in order.   

4.      Clean up Your Books II.  I get it, you are a small business owner and you want some of the perks of owning a small business.  So, you decide to buy a building and have your company pay (mildly excessive) rent to you.  You hired your son to be your bookkeeper for $75,000 a year in stead of paying a bookkeeper $10,000.  You bought a company condo in Florida, and decided that the company could really use a yacht and a Porsche 918 to run (business related) errands.  I’m not here to judge (well maybe I am a little), but if those expenses are on your books when you present your P&L to a buyer, you are shooting yourself in the foot.  When you are getting ready to sell, stop thinking about reducing your tax bill (and living like a Rockefeller), and clean up your books.  Get a real estate agent to give you’re the market value of your rent.  Reduce salaries paid to family members to market rate (or just hire someone else).  Eliminate all non-business related expenses from your business.  Your books should reflect the most efficient operation of your business to get you a better return.

5.      Make Your Business Shiny.  Quick question:  who has more leverage, a person who looks like they must sell, or a person who looks like they don’t have to sell?  Years ago, I worked with a man who owned a restaurant and decided that he was going leave his business in a couple years.   So, for close to three years he spent next to nothing to fix his equipment, his furniture, his fixtures or anything else.  When buyer came around and saw the mess that was waiting for them (torn carpets, ovens on their last legs, dated furniture, and worn out fixtures), it directly reduced what they were willing to pay.  More importantly, the buyers knew that the seller had to sell, otherwise he would have to absorb the costs of updating the FF&E.  He had painted himself in a corner.  When you present your business for sale, it should look like you could run it for another 10 years if you wanted to.  Operate your business as if you will never sell, until you do.  Keep your vital equipment in good repair, replace worn fixtures, keep employment agreements up to date, enforce non-compete agreements, protect your copyrights and trademarks, and update your vendor and customer agreements. 

There are, of course, more things you can do, and each industry has other steps that might be useful. But, if you can take simple steps that will give potential buyers confidence that they can replicate the success of your business, you will  be more likely to sell your business and get paid fairly for it.

Peter C. Brehm, J.D., LL.M., CVA

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Business Transfers and Changing Tax Rules

Wednesday, December 7, 2016 @ 10:12 AM
Author: Steven Ness

Last Thursday, December 1, 2016, there was a hearing before IRS regulators concerning the potential elimination of discounting the value of transferred business interests, a significant estate planning business succession technique often used in the transfer of closely held or family owned businesses.
In October, the IRS has issued proposed regulations to Section 2704 of the Internal Revenue Code that could dramatically reduce the ability to utilize well accepted discounting techniques used in valuing business interests being transferred. Specifically, these proposed regulations would likely restrict the application of “lack of control” or “lack of marketability” discounts when determining the value of the business interest being transferred. The loss of this technique creates serious tax implications, affecting taxation of capital gains, gift tax exemptions and estate taxes.
Although the 2016 federal estate tax exemption is $5,450,000, per person, that cap is subject to change by either congressional or Presidential pressure. If long recognized discounting method, relating to the accepted value of transferred business interests is lost, owners of family and closely held business could be paying more taxes as a result of a business transfer.
Since 1990, when Section 2704 was enacted by Congress, the IRS has attempted to close estate and gift discounting. Until now, that attempt by the IRS has been unsuccessful. The new proposed regulations use the authority granted under Section 2704(b)(4), which gives the IRS the authority to provide in regulations in determining the value of the transfer of any interest in a corporation or partnership to a member of the transferor’s family, if such restriction has the effect of reducing the value of the transferred interest . . . but does not ultimately reduce the value of such interest to the transferee.”
There are questions as to whether the proposed regulations exceed the regulatory authority of the IRS, and while the promulgation of these regulations will likely be challenged, that challenge would be well after the proposed regulations are effective.
If these changes are adopted as written, they will have a direct impact on estate planning considerations for owners of family controlled entities. These new regulations will effectively eliminate discounts for lack of control or marketability in valuing these interests. While there may still time to complete transfers before the proposed regulations become effective, that preemptive planning may be for naught. If planning individual dies within three years of the transfer and after the new regulations are effective, the transfer could still be taxed under these new regulations.
It is however, a double-edged sword. Given that the current federal estate tax exemption is $5,450,000, there is only a limited population that will ever be subject to this federal estate tax. That limited application of federal estate taxes, coupled with the current step-up in basis rules, benefits tax payers, who cannot be subjected to the taxing authorities attempts to apply discounts to that stepped-up bases. As an example, a business owner who dies and passes his or her business interest to the next generation, passes along a business interest with a higher value, providing an increased step-up in basis.

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Seminars on Business Valuation and Buy-Sell Agreements

Thursday, September 22, 2016 @ 12:09 PM
Author: Peter Brehm

At Business Law Center, we we do a number of things to help small business owners plan for the future. In conjunction with SCORE and Northeast Bank, on October 27, and November 3, 2016, we will be hosting two seminars geared towards helping small business owners protect their business, and improve the value of their business.

In Session 1, Succession Planning – Preparing to Leave Your Business, you will learn:

• Why should I have a plan?
• What happens to my business when I die?
• What happens if my partner dies, gets disabled, or divorced?
• How to get my business ready to sell?
• Could I sell my business now? And retire?
• How do I protect my family?
• How do I minimize taxes?

In Session 2, What’s Your Business Worth? you will learn:

• How can I determine the value of my business?
• What is the value of my goodwill?
• How do I decide how much insurance I need?
• What are my partners’ shares worth?
• Can I buy them out?
• Can my employees afford to buy me out?

For more information, and to register, you must go to SCORE’s website HERE.

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Proposed IRS Regulations May Eliminate Valuation Discounts for Gifts of Family Ownership

Sunday, September 18, 2016 @ 10:09 AM
Author: Peter Brehm

On August 4, 2016, the IRS published in the Federal Register a set of proposed new regulations under Chapter 14, Section 2704 of the Internal Revenue Code. These proposed regulations would have a significant impact on the valuation of private business entity interests for transfer tax (estate, gift, and generation-skipping) purposes.  Currently, business appraisers will examine real world restrictions on ownership interests (such as limitations of voting rights, control, etc.), and will often apply significant discounts to stock that is gifted to family members.  The discounts are intended to reflect the reality that potential buyers will pay less for stock that is restricted than it will for stock that is not restricted.
Under the proposed regulations, appraisers would be required to conduct valuations assuming hypothetical circumstances that often do not coincide with market conditions.  In other words, appraisers would be expected to assume that restrictions of the stock being transferred do not exist. This would cause them to determine a fair market value that ignores otherwise applicable valuation discounts, resulting in a value determination that may not match what the market would actually pay.
If these regulations are enacted in December 2017 as planned, valuation discounts for transfer interests will essentially be eliminated.  This will redefine how these interests are valued and most likely limit the financial benefits of these transfers.  The proposed changes would affect anyone who plans to transfer equity interests to family members. It is essential to approach this process in the company of a seasoned business valuation expert who is adept at navigating the complex authorities in action during these transfers.

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When Doing Nothing Can Cost You Everything: Why You Need a Business Succession Plan

Thursday, February 11, 2016 @ 12:02 PM
Author: Peter Brehm

No business owner would deliberately risk the very enterprise that could help fund his or her retirement and prove to be a lasting legacy. Yet, an owner who has failed to plan for business-succession or exit upon retirement does exactly that. Here’s how to avoid the sometimes substantial cost of doing nothing.

“Albert” is the 63-year old owner of a profitable retail operation that boasts annual sales (revenue) of around $1 million. Since launching the business 20 years ago, Albert runs the day-to-day operations full time, and has been drawing an annual salary of about $60,000 in recent years. He also employs four part-timers to run the cash registers and stock shelves now and then. Currently, the entity holds about $125,000 worth of inventory (based on current purchase price of items) and around $100,000 in equipment. A quick estimation of the business’s value can be gauged by applying the rule-of-thumb similar businesses (ones selling the same product or service) use in his geographical area: calculate 50% of average annual sales over the past three tax-reporting years.

In Albert’s case, that would amount to a business worth roughly $500,000 (business value including equipment, good will, etc.).

The strain of working 12-hour days in retail is starting to take its toll on Albert’s health, however. Albert agrees that he can’t keep up his current pace much longer, but has procrastinated on actually coming up with a business-transition or succession plan, feeling confused and overwhelmed at the thought of it. “I’ll probably just work until I can’t anymore,” he laughs. When his friends ask what he’d actually do if he were unable to work, he scoffs, “That’ll never happen.” A few weeks later, a fall from a ladder puts Albert in the hospital for several weeks. With no one to take his place, Albert thinks it best to consider closing up for a while, if not permanently. “It had a good run,” he says, thinking that this outcome was probably inevitable.

An All-Too Familiar Story

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New Minnesota Estate and Gift Tax Laws

Thursday, June 6, 2013 @ 10:06 AM
Author: Steven Ness

At the end of May the Minnesota Governor signed a bill into law that will impact people who reside in Minnesota and those who claim their residence in another state but own property in Minnesota.  Minnesota is now the second state (after Connecticut) to impose a gift tax. The new law also imposes a Minnesota estate tax for all property located in Minnesota held in pass-through entities (an LLC, Sub S Corp or partnership). Some key provisions provide:

  1. A Minnesota gift tax of 10 percent will be imposed on certain taxable gifts made by Minnesota residents and non-residents owning property located in Minnesota.

·         Beginning on June 30, 2013, Minnesota residents and non-residents will be subject to Minnesota gift tax on all transfers of real property located within Minnesota and transfers of tangible personal property that is customarily kept in Minnesota at the time the gift is executed. In addition, Minnesota residents will also be subject to Minnesota gift tax on transfers of intangible assets (e.g., cash, securities, business interests).

 ·         Each person has a lifetime exemption of $1,000,000 from the Minnesota gift tax. The Minnesota gift tax only applies to transfers that are treated as taxable gifts for federal gift tax purposes. As a result, certain gifts that are not subject to the federal gift tax – including transfers falling under the annual exclusion cap ($14,000 in 2013), gifts to spouses, charitable gifts and certain transfers for educational or medical purposes – will not be subject to the Minnesota gift tax.

 ·         This may be particularly important for people who have not yet taken advantage of their $5,000,000 federal gift, estate and generation-skipping transfer tax exemptions (indexed for inflation to $5,250,000 in 2013)

 

  1. Unlike many other states, Minnesota still has an estate tax on taxable estates that exceed $1,000,000 (with a top tax rate of 16%). Beginning in 2013, individuals who die resident in Minnesota or those who own property located in Minnesota will be required to include in their Minnesota taxable estate taxable gifts made within 3 years of death.

 

  1. For people dying after December 31, 2012, who own a pass-through entity (such as an LLC, S Corp or partnership) the location of real or tangible personal property held in the entity will be determined as though the entity does not exist. This means that property located in Minnesota held in pass-through entities will be subject to estate tax.

 ·      Under prior law, a non-resident owner of an interest in a pass-through entity that owned real estate, inventory or equipment in Minnesota was not subject to Minnesota estate tax on that property. The new law will subject such property to Minnesota estate tax, even if the business owner or investor has no other connection to Minnesota and even if the business entity is organized and operated in another state.

·         Non-Minnesota residents who may have previously transferred Minnesota situated property to a pass-through entity, in order to avoid the Minnesota estate tax, should to review these transfers. This is no longer an effective way to reduce or avoid Minnesota estate taxes.

·         Since the new law does not apply to Minnesota-situated property owned by C Corporations people owning pass through entities will want to consider whether a conversion to a C Corporation is appropriate.

At this point in time, the new law does not include a similar provision for Minnesota gift tax. After June 30, non-residents may be able to continue making gifts of interests in pass-through entities owning Minnesota property, without triggering a Minnesota gift tax. It must be remembered that any such gifts made within 3 years of death will be included in the gifting individual’s Minnesota taxable estate. People who desire to complete gifts of Minnesota situated assets should consider doing so as soon as possible.  It is anticipated by many that the Minnesota gift tax provisions will be modified to align with the new Minnesota estate tax provisions in one of the next legislative sessions.

 

 

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It May Be Time to Review Your Estate Plan

Wednesday, March 6, 2013 @ 09:03 AM
Author: Steven Ness

For more than a decade the estate planning landscape has been foggy at best.  During that entire period, existing laws created “automatic” changes that many tax and legal professionals found difficult to predict.  The passing of the American Taxpayer Relief Act of 2012 (the “2012 Act”) at the close of 2012, finally makes the estate and gift tax laws “permanent,” meaning that they are not scheduled to expire, be repealed or rolled back. This is a significant change because since 2001 taxpayers and their advisers have had to plan based on an uncertain statutory framework.

The 2012 Act sets the estate tax exemption amount at $5 million. This is the amount of money that can pass estate tax free to any individual without triggering federal estate tax.  Since this exemption amount will be adjusted for inflation, the exemption amount in 2012 was actually $5.12 million and it is predicted to rise to $5.25 million this year.

The 2012 Act unifies the estate tax with the gift tax, making the lifetime gift tax exemption amount also equal to $5 million (adjusted for inflation). The generation-skipping tax (“GST”) exemption amount is also set at $5 million (adjusted for inflation). As a result, a person can gift over $5 million during life ($10 million between spouses) and not trigger any transfer tax.

The maximum estate and gift tax rate was increased from 35% to 40%.

The “portability” of exemptions between spouses has been permanently extended so that a surviving spouse will be able to utilize his or her last deceased spouse’s unused exemption amount. This does require the filing of a federal estate tax return, but with proper elections built into a carefully prepared estate plan, a surviving spouse can protect up to $10 million (adjusted for inflation) if his or her deceased spouse did not utilize any of his or her exclusion amounts.

While the exemption amounts are high and portability enables a surviving spouse to use both spouses’ exemptions, there are still many reasons why planning during life is very important, including:

  1. All appreciation on gifted assets escapes federal and state estate taxes. For this reason, it still may make sense to make lifetime gifts if you anticipate that assets may appreciate and/or grow to a level that exceeds the exemption amounts.
  2. While the federal exemption amount is $5 million, the Minnesota estate tax exemption amount is still $1 million. A $10 million estate may not be subject to federal estate tax but will be subject to approximately $1 million in Minnesota estate tax.  Proper planning can reduce or eliminate this $1 million state estate tax exposure.
  3. While the estate tax exemption is portable, the state level estate tax exemption and the federal GST exemption are not portable. If not properly planned for, these valuable exemptions can be wasted, costing significant tax dollars.

Steven E. Ness is an estate planning attorney for Business Law Center, PLC in Bloomington, Minnesota.

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Tax Plans Must Have A Business Purpose, and Sometimes Even Tax Attorneys End Up in Jail

Friday, September 14, 2012 @ 10:09 AM
Author: Peter Brehm

When I was in the mire of my tax education I was presented with this seemingly contradictory reality:

1. Congress creates rules in the tax code (including deductions and credits) to encourage businesses to engage in specific types of conduct (buy certain products, hire certain types of employees, or provide specific benefits); and

2. Congress (and the IRS) also creates rule prohibiting businesses from claiming those tax benefits unless there is a substantial business purpose for the transaction other than tax savings.

One of the frustrating parts of tax planning is coming to grips with the idea that Congress wants to control your behavior with rewards, but then denies you the reward if they find out that you only did it for the money. Its a bit like offering someone $1,000 to be your friend, and then refusing to pay them when you find out that they only liked you for your money. So the game becomes convincing the IRS that you love their sense of humor and just as much as (if not more than) their deductions.

Successful business owners are like gold to tax planning consultants because they have the two things that all tax planners need: taxable income and a desire to send less of that income to the government. As a result, the more successful you are, the greater the chance that you will find yourself in contact with an army of tax planners and consultants. Tax planners (and tax attorneys) range from conservative (declare all income at the highest possible tax rate), moderately creative (use the plain language of the tax code to reduce taxes within the letter of the law), aggressively creative (expand the possible meaning of the code, and fill in gaps of the code to aggressively reduce taxes), to criminally creative (knowingly engaging in planning and conduct that is contrary to the law to avoid taxes at all costs).

Its not always easy to tell which kind of adviser you are dealing with, but the line you should never cross (and a clear indication that you are entering the world of the criminal planner) is a fairly bright one: would I do this transaction if I wouldn’t save taxes? If the answer is yes, then you are probably fine. If the answer is a resounding NO, there is a good chance that something is amiss, and that you should speak with a lawyer (unrelated to the people selling you their plan) about the transaction. For example, would you take all of your liquid assets, transfer them into a trust controlled by someone you don’t know in another country, who then deposits the funds in a third world bank? If you can think of a good reason for your business to do that, and you were going to do that anyway, any tax benefits will probably be appropriate. If the primary, if not exclusive, reason was to save taxes then tough times may be ahead.

Often times these people will have already anticipated your objections, and may present you with a letter from a reputable lawyer or accounting firm to alleviate your fears. Rather than calm you, let me suggest that this is exactly the time to reach out to a qualified tax lawyer who has no stake in the proposed transaction. Why? Because some lawyers (and I am going to shock some of you here) are not particularly ethical.

Yesterday a lawyer out of Chicago pled guilty to conspiracy and tax evasion (in a scheme in which she made $1.6 Millon). Her crime? Knowingly writing false tax opinion letters. In those letters, the attorney opined that transactions without any purpose other than tax avoidance had “a substantial business purpose”. The client needed the letter to justify a transaction that was solely for tax avoidance and the lawyer was willing to write the letter for money. Now, they are all going to prison. Here is a copy of the plea agreement if you have ever wanted to see one.

There are a LOT of very good and ethical tax planners in this country, with a LOT of very good and creative tax planning ideas and opportunities. And to be very clear, the tax code is almost beyond common sense comprehension, and some of the best legal and tax minds will disagree among themselves about what the code does and should say. So nearly all tax planning, even good faith conservative planning, has some level of risk associate with it. But there are three things I want people to understand: 1. whatever planning you do should generally be tied to a purpose beyond tax savings; 2. there are professionals who will advise you to take a tax benefit you are not entitled to so that they can make money off of your money; and 3. when you enter into those kind of transactions, no matter how many letters you have saying it was OK, everyone can end up in jail.

Peter Brehm is a tax attorney practicing with the Business Law Center in Minneapolis, Minnesota and Scottsdale, Arizona.

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Gifting Stock: Use a Formula, Not a Savings Clause

Thursday, August 9, 2012 @ 02:08 PM
Author: Peter Brehm

Small business owners often struggle finding ways to transfer the value of what they have built to their children and grandchildren.  The current tax law permits a parent to gift $13,000 to each child without paying gift tax.  So, for example, a husband and wife with 4 children could gift $26,000 in stock every year to each child ($104,000 per year) without paying tax.   As most small business owners know, however, establishing the value of small business stock is not easy to do, and if the IRS decides that the amount of stock you gave exceeds the annual exclusion amount, there is the potential for a rather punitive gift tax.

Many practitioners have tried to remedy this situation by adding a ‘savings clause’ to the gift that says: we are gifting X number of shares to each child with the expectation that the value of the shares does not exceed the gift tax exclusion amount, and if the IRS finds that  X number of shares exceeds the gift tax exclusion amount, we take back enough of the gift so that no tax is owed.  The IRS, and most court have rejected this approach.

However, the Tax Court has held that a gift of stock based upon a formula, where the gift is for a set dollar amount (not a specific number of shares) the taxpayer can effectively create a gift that will never exceed the exclusion amount.  In Wandry v. Commissioner, the court held that “[a] savings clause is void because it creates a donor that tries ‘to take property back’.  On the other hand, a ‘formula clause’ is valid because it merely transfers a ‘fixed set of rights with uncertain value’.  The difference depends on an understanding of just what the donor is trying to give away.”

For the small business owner the solution is clear: when planning around the gift tax exclusion, you should use a formula based gift, not a savings clause.

Peter Brehm is a small business and estate lawyer practicing in Minneapolis, Minnesota and Scottsdale, Arizona.

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