December 2016 eNewsletter

Transition Process Empowers

Larry Grypp, President of The Goering Center

It was a rough Presidential campaign, but you could feel the shift within a day or two -- at least among the president and president-elect, if not the electorate.

The time to focus on a peaceful transfer of power had begun. The orderly process was starting.

Not that the process itself lacked drama and discord, but there was a tempering influence that came into play. Mr. Obama and Mr. Trump, in their own fashion, recognized it was time to hew to a process that has distinguished the American election system since the days of George Washington. The leadership mantle was about to pass.

As you read this, no doubt there is still some turmoil, but nothing like the convulsions that can be seen in other countries around the world when one leader takes over from another.

Whatever anxiety comes with a family business moving to the next generation of leadership hardly scales to the enormity of the U.S. Presidency, but if you are in close quarters, it can pose some of the same perils of discord, confusion and uncertainty.

Why is process so important?  And why do family businesses, in particular, sometimes shy away from it?

Process, properly designed and executed, provides stability and continuity. It sets expectations and defines clear measures and milestones. It keeps everyone on the same page, aligned around what needs to be considered and how everyone is accountable to that.

Interestingly, most embrace instilling process and discipline around investment of assets -- in new equipment, facilities, an acquisition, or a new product line. We can’t imagine just throwing money at those situations and hoping for the best. The process tempers impulse and challenges thinking along the way. It ensures a good decision.

The leadership transition process of a family business is as critical. Owners may feel a process interferes with a parental desire for their children but it actually safeguards that relationship. Particularly in a family business where the transfer to the next generation may seem to be a foregone conclusion. It is the process that makes sure that it is a good decision for the business and ultimately for the family’s own legacy and health.

Climbing the Tax-Efficiency Pyramid to Lower Taxes

Tim Voorhees, Principal Partner, Matsen Voorhees Mintz Law, and President Family Office Services; Scott Sims, Principal Partner, The Pinnacle Group


  • More than 2,000,000 Americans now earn more than $500,000 per year.  It is common to see business owners earning an extra $200,000 or more of income each year that is not needed for current lifestyle needs. This excess income is usually taxed at marginal tax rates of 50% or more unless additional planning is done.
  • Business owners can minimize unnecessary income taxes by climbing up a “tax-efficiency” pyramid to realize greater benefits at each higher level.
  • The most powerful income tax strategies typically generate income tax deductions in the year investments are funded, then can grow tax-free and make tax-free distributions.
  • The most effective planning instruments typically involve the integration of legal, investment and insurance strategies. Collaboration among professional advisers is therefore more important than ever.

To illustrate the impact of taxes, it is useful to look at how taxes reduce returns across time.   Consider an owner who has $500,000 of excess income (e.g., income not used for lifestyle expenses) this year or over the next few years. If the 50 percent rate on contributions applies along with the 38 percent rate on withdrawals, the $500,000 is worth only $662,287 in 30 years.  On the other hand, if the owner invests the $500,000 in vehicles that generate current tax deductions and avoid taxes on investment income and distributions, the $500,000 can grow across 30 years to be worth more than $5,000,000.  Which would you prefer your half-million of extra taxable income grow to -- $662,000 or $5,000,000?

The impact of taxes will vary depending on the timeframes and investment returns.

Obviously, investments will perform better if there are no taxes on the contributions, accumulation, and withdrawals. Fortunately, American tax policy encourages the pre-tax funding of investments using a variety of planning instruments discussed below.

Sorting through the different tax planning options may seem like a herculean task; however, the pyramid diagram simplifies the decision process. The six levels of the pyramid graphic, explained below, illustrate how business owners can be rewarded for advancing from traditional to more innovative strategies.

Level 1: The bottom level on the pyramid depicts how most owners receive their income. Their paychecks show heavy FICA, FUTA, SUTA, and other payroll taxes as well as withholdings for state and federal taxes. As indicated on many paystubs, more than half of the income can be lost to taxes at level 1. Moreover, after-tax investments in retirement vehicles can trigger additional taxes, as indicated on the above table. Obviously, clients need to find more tax-wise solutions!

Level 2: Climbing the pyramid to level 2 affords clients opportunities to invest in ERISA qualified plans. Such plans include 401(k) plans as well 403(b)s, SIMPLE plans, profit-sharing plans and defined benefit plans. While employee deferrals used to fund qualified plans will still be subject to payroll taxes, the heavy state and federal income taxes are deferred until money comes out of the qualified plans.

Level 3: Business owners and highly compensated employees often want more tax benefits than qualified plans afford. Too often, the top-heavy rules limit the amount of contributions by highly compensated owners and executives. To work around the ERISA restrictions, financial planners offer a variety of non-qualified deferred compensation plans.

Level 4: The Level 4 solutions include a variety of charitable planning instruments that allow for large income tax deductions when they are funded as well as tax-deferred growth on the plan balances. Moreover, the distributions may have only moderate withdrawal taxes. For example, charitable remainder trusts (CRTs) can distribute tax-free or capital gains income. These charitable tools can be custom-designed for each individual to start retirement income when income is most needed or tax rates are lowest. For these reasons, the charitable tools at level 4 can provide better bottom line benefits than those generated at levels 1-3.

Level 5: Business owners focused on retirement security and income may reject level 4 solutions because “charity begins at home.” Fortunately, there are charitable solutions, such as a Super CLAT designed with the current low 7520 rate that can increase what goes to the donor throughout retirement. For substantial benefits from non-charitable tools, employers will often take deductions for a Section 162 plan.

Level 6: Creative planners continue to find synergistic combinations of planning instruments that can provide benefits that exceed those illustrated in Level 5. Capital Split Dollar (“CSD”) helps employers take income tax deductions for funding tax-free retirement and death benefits for key executives. An Employee Stock Ownership Plan (“ESOP”) can provide tax-free build-up of assets. When the ESOP is combined with a charitable trust, the resulting “ChESOP” can produce both tax deductions in the early years and tax-free income in later years.


As businesses mature, generating excess income for their owners, the need for creative income planning becomes all the more important. Successful business owners needn’t settle for solutions limited to level 1 or level 2 of the tax-efficiency pyramid. There are compelling reasons and great financial rewards for reaching higher - to levels 3, 4, 5 and 6 in the tax efficient lifetime income planning process.

Proposed Regulations Add Tax Bite To Family Transfers

Scott Cress, CPA, CVA, CM&AA at Barnes Dennig CPAs

In early August 2016, the IRS released proposed regulations regarding the valuation of interests in family-controlled entities. Specifically, the Proposed “2704” Regulations focus on the elimination of most discounts when ownership interests are transferred between family members when a majority interest is held inside the family. If adopted in their current form, they only apply to transfers made at least 30 days after the restrictions become final. Huge opposition has been mounted and the Treasury has received thousands of pages of comments for a December 1st hearing that is only scheduled to last two hours. As of the time of this writing, it is the consensus of most experts that the form they end up taking will be substantially different and the timing of implementation is uncertain.

By way of background, valuations of interests in corporations and partnerships for estate, gift, and generation-skipping transfer tax purposes can currently be discounted for minority ownership, lack of marketability, and lack of control. This allows a taxpayer to transfer family owned entities to the next generation at a discount from what the underlying value is. The new rules would eliminate the lack of control discount and suppress the lack of marketability discounts that are typically available.

We believe the main points of the proposed regulations are as follows:

  • Transfers within three year rule (“deemed death bed planning”) – The proposed regulations have added a bright line test for lapsing rights. If transfers within three years of death result in a lapse of a liquidation right for the transferor, the transferred shares will be included in the transferor’s gross estate for Federal estate tax purposes. Per the IRS, this bright line test will avoid the fact-intensive inquiry which both the IRS and the taxpayer must go through to determine a donor’s subjective motive.

We personally believe that this is a gross over-reach by the IRS.  Three years is a long time, and a company’s strategic plan may be updated several times within that time-frame.

  • Disregarded restrictions – This is the most far reaching aspect of the proposed regulations, which essentially values transfers of interests in family-controlled companies as if the holder has a put right to sell the interest within six months. They will allow the holder to be paid by a note as long as the note is at market rates (no AFR) and the term is no longer than six months.

How many companies operate in such a manner where all shareholders can (in theory) take their share at any time? Is every company now required to keep cash on hand or maintain enough untapped credit to fund the liquidation events when requested?  Many valuation experts believe this “put right” would create a new form of discounting in and of itself.

  • Definition of family control – The regulations have tightened the definition of family control of an entity. The IRS concluded that the grant of an insubstantial interest in the entity to a nonfamily member should not preclude the application of 2704(b), because such nonfamily member interest generally does not constrain the family’s ability to remove a restriction on the liquidation of an individual interest. The IRS concluded that the presence of a nonfamily-member interest should only be recognized where the interest is economically substantial and longstanding, thus likely to have a more substantive effect.

In essence, no inviting friends and neighbors to join the family business to circumvent the rules.

To date, the regulations are proposed, and are not effective until made final and promulgated.  Most proposed regulations, even non-controversial ones, are generally not finalized for two or more years. 

And, let’s not forget our new President-elect.  Trump’s campaign called for a repeal of the federal estate tax.  Many believe this is simply unaffordable and unpassable in a Senate where he does not have a filibuster-proof majority.  However, we may see an estate tax overhaul whereas the current top federal estate tax rate of 40% is traded for a softer capital gains tax rate at 20%.

Nothing is certain but uncertainty.  As we’ve seen in the past, any changes in the law are subject to change in the future but we believe valuation-based planning will remain an important strategy for estate tax purposes for years to come.

Uncertainties and Opportunities

Lee Stautberg, Dinsmore & Shohl, LLP

The recent Presidential race and general tenor in Washington, the fact that the markets hovered near all-time highs while interest rates hovered near all-time lows and the constantly changing tax code raise a number of concerns for families and businesses.  Even though we cannot predict the future, we can take advantage of the current federal and state laws to prepare for the future and protect our families.  Let’s consider three opportunities that may be available to you or your family. 

1. “Permanent” Estate Tax Relief and Reduced Tax Rates.  As part of a 2013 compromise bill reached to avoid the “fiscal cliff,” the highest rate on estate taxes was set at 40% and the Federal estate tax exemption increased to $5 million dollars and is indexed for inflation.   In 2016, the estate tax exemption sits at $5,450,000 per individual, or $10,900,000 for a married couple.   Just as important, the exemption can be transferred between spouses rather than the prior regime which was a “use it or lose it” system.  These estate tax exemptions are supposed to be “permanent.”  Nonetheless, for the past two years, President Obama’s budget has included a provision to reduce the exemption to $3.5 million dollars and remove the inflation adjuster.  Looking forward, our President-Elect, Donald Trump, has made the repeal of the estate tax a part of his agenda.  If, how soon, and exactly how any estate tax repeal would be implemented are open questions.

Also, President-Elect Trump has declared that his agenda includes lowering individual and corporate tax rates.  For those who believe tax rates will be lower in 2017, they may want to take a gamble on the prospect of lower-rates and defer income to 2017.

2. IRS Proposed Regulations. In early August, the Internal Revenue Service issued proposed regulations to Section 2704 of the Internal Revenue Code.  If finalized, these regulations may impact the valuation discounts on the transfer of family controlled entities.  In essence, the proposed regulations would disregard certain transfer restrictions or applicable discounts on the transfer of family controlled entities.  Many public interest groups have voiced concerns that, if finalized, these proposed regulations will be “unfair” to family owned businesses and could make it harder to transfer businesses to future generations.  However, since the issuance of these proposed regulations, the IRS has made numerous public statements that the regulations are not intended to eliminate traditional valuation discounts applicable to the valuation of family controlled entities related to lack of control and lack of marketability.  In any case, the IRS seems to be in no hurry to finalize these proposed regulations and due to the up- coming changes in the Presidential administration, it is unlikely that these proposed regulations will be finalized anytime soon.  So, there is time to carefully review your estate and business succession planning to ensure that you can take advantage of the current law. 

3. Stable Accounts. For families caring for loved ones with disabilities, there is a new Ohio program to help you set aside funds.  The new STABLE Act allows individuals with qualifying disabilities and their families to save and invest money through special investment accounts without losing eligibility for government benefits, including Medicaid.  

An individual has a “qualifying disability” if he or she developed the disability before age 26, has been living with the disability for at least one year or expects the disability to last for at least one year, and meets one of the following criteria: he or she (i) is entitled to Supplemental Security Income because of the disability; (ii) is entitled to Social Security Disability Income because of the disability; (iii) has a condition listed on the Social Security Administration’s List of Compassionate Allowances Conditions; or (iv) is able to self-certify a disability or diagnosis.  Self-certification simply requires that the individual agree to the following statements when enrolling for a STABLE account: (i) the individual has a written, signed diagnosis from a licensed physician; and (ii) the individual is either blind or has a medically determinable physical or mental impairment that results in marked and severe functional limitations.  Proof of the diagnosis is not required at the time an individual applies for a STABLE account, but a copy of a physician’s diagnosis must be provided upon request. 

Common examples of qualifying disabilities include autism, cancer, cerebral palsy, cystic fibrosis, Down syndrome, epilepsy, multiple sclerosis, sickle cell disease, and some mental disorders.

The program allows participants to select from five investment options and contribute up to $14,000 per year to the account (up to $426,000 total).  Contributions to the account, investments within the account, and qualifying distributions are not treated as income to the participant and do not count against the participant’s eligibility for certain government programs.   Qualifying distributions include expenses for the participant’s health, education, housing, transportation and basic living expenses.  

Any eligible individual, the parent or guardian of an eligible individual, or the holder of a power of attorney for an eligible individual can establish a STABLE account.  Although it is an Ohio program, residents of all states may open an Ohio STABLE account.  For more information or to set up an account, go to

 Even in this era of uncertainties, we have many opportunities to take advantage of current laws to provide for ourselves and our loved ones.  The key is to take time out to plan and make the most of these opportunities.

Forget the Price – Focus on the ATWAM

William R. Ernst Managing Director at GBQ Partners

What is my business worth?  Eventually every business owner asks this question.

Worth, like beauty, is in the eye of the beholder.  What your business is worth to you is likely to be a far different number from what your business is worth to a prospective buyer.

In determining a price for a business, it is common practice to look at past profits and multiply them by some capitalization factor. However, a business has value because of what it will produce in the future – period. End of story.  A buyer cannot pay tomorrow’s salaries based on prior years’ profits.  Historical profits are only important from the perspective that they may be a good predictor of the future. Negotiations should be based on what is anticipated to be coming down the road, not what can be seen in the rearview mirror. What your business was worth yesterday may not be anywhere near what your business will be worth tomorrow.

The price that you will get for your business is mostly dependent on how much risk you are willing to keep.  Right now you have all the risks - the normal business risks as well as the global risks of technological change and economic or political uncertainty.  If you expect to transfer all the risk to the buyer in exchange for an upfront cash payment - don’t expect to get a great price.  If, on the other hand, you are willing to transfer the risk to the buyer over time, the buyer will be more likely to give you a better price.

While price is important, the success of a deal is more dependent on the terms of the agreement than the price at which the deal is struck.  $5,000,000 cash up front is more valuable than $500,000 per year for ten years.  $1,000,000 with a solid guarantee may be worth more to you than a promise to pay you $2,000,000 from future profits that may or may not come about.  $500,000 that is taxed to you as a capital gain is generally worth more than $500,000 of ordinary income. 

Most failed deals have little to do with price.  Most deals fail because the owners had unrealistic expectations of what the price should be.  After all, they worked all their life to get to where they are.  Somebody should be willing to pay a lot of money for their business.

Forget the price.  Decide what your after-tax-walking-away-money (ATWAM) needs to be to make it worth your while; then let the negotiations begin.  If you get your number, walk away happy.  If you don’t get it, work on making your business more valuable to the next potential buyer.