One client, a father and daughter in a family cosmetics manufacturing business, had a situation that was tearing the family and the business apart. The father, a major shareholder, was ready to retire. Selling the business would give him liquidity and broaden his estate planning options. And an outside buyer was already waiting in the wings.
His daughter, however, passionately wanted to maintain the business but could not find a way to accomplish a buyout without severely draining the company's cash. In addition, she wanted to retain a key employee without surrendering even a portion of the family's ownership. To complicate matters, the company provided pension coverage for an aunt and a job for a grandson — both would terminate if the outside offer were accepted. Considering the differing viewpoints, it would take more than traditional thinking to bring all sides together.
Our intimate knowledge of the company, individuals, and family relationships played a decisive role in satisfying all parties. We conceived a multilayered plan that combined debt consolidation and a family freeze with a leveraged buyout. It featured a compensation arrangement that met everyone's needs. A carefully planned strategy mitigated the tax impact. This solution facilitated a sound exit for the father, kept the business in the daughter's hands, and provided for the aunt and grandchild.
A major New York law firm was considering opening an office in a southwestern city and asked for our opinion on an approach. Weighing a host of options, we concluded that a merger would be the most effective approach and, after several candidates were identified, we swung into action:
Relying heavily on our insights and conclusions, the client was able to make a confident decision. Within 90 days, the entire process was complete. Monitoring the merger over the next year, we continued to offer suggestions to help our client achieve expectations. Asked to compare our original projections against the outcome, we found the projections came within a few dollars of actual results.
Joining the partnership has many perks, but several major firms recognized that, for some young partners, that tantalizingly sizeable new paycheck can trigger a spending spree. Asked to counsel these partners, Berdon advised that their W-2 days were over — they were now on Form K-1 with no withholding and that they had personal responsibility for their cash flow planning.
As partners, they could no longer take advantage of the firm’s flex-plans, although they may be able to deduct a greater portion of medical expenses. Their social security tax outlay will be higher than when they were employees, and they will be responsible for taxes in any states or jurisdictions where the firm operates. Alerting them to these and other factors, we helped them prepare to meet their tax obligations on a quarterly basis. For those who did go off the deep end a bit, we suggested that they earmark any year-end bonuses to help right their financial ship sooner and not let debt accumulate.
The loans were made during those heady times when money flowed freely and renegotiating debt was just a matter of paperwork. That was then, and now balloon payments were on the horizon for this global practice and the easy money spigot was turned off.
Reviewing the firm’s capital structure and partner compensation and comparing it to industry standards, Berdon laid out a path that would enable the firm to pay down its debt before the balloon burst and emerge much healthier on the other side. We devised a plan where the partners would, over time, contribute more to the firm’s capital. Accordingly, we suggested that the partnership agreement be amended to require that all new partners contribute a greater percentage of capital to the firm. Moreover, we recommended that a portion of compensation be tied to the amount of business a partner brings in so that no partner’s income would exceed the value of the business generated. We urged that the agreement should also include a formula placing limits on the payouts given to retired partners.
These steps were all part of a 3-year plan designed to infuse more cash into the firm to manage its debt and eventually place it in a stronger cash position with greater partner involvement in the firm’s financial future.
It had reached a danger point. One person at this boutique practice served as CFO, administrative partner, and IT director, among other responsibilities. The managing partner called Berdon in and, seeing serious problems with internal controls, we made a series of recommendations to end this concentration of authority and set up a system of checks and balances:
Ten years earlier, Berdon provided significant input on a comprehensive partnership agreement for this venerable real estate practice — covering capital contributions, income allocation, and succession, among many other areas. Circumstances had changed, and we were called back to revisit the economic aspects of that agreement. Over the years, the firm had added many lateral partners and there were concerns that it may not be able to fund payments for partners who were nearing retirement.
Our first step was to project the payments the firm would have to make to fulfill the provisions in the current partnership agreement and contrast it to likely available funds. Identifying the potential shortfall, we suggested options to reduce or defer payments to keep the firm financially solvent and bring it to the next generation.
The growing specialty practice, an LLP, had identified an older firm that was a cash basis S corp as a merger candidate. Berdon saw that the difference in the structures of the two firms raised several issues that could impact the potential merger:
Because of the number of factors that could impede the merger, we suggested that teh firms might want to consider working cooperatively as a way to learn, beforehand, if they could work together and blend culturally.
Management was caught by surprise when it came to light that a retired partner of this 15-person boutique practice had taken out $150,000 more than he was entitled to. Asked to untangle how this could happen, Berdon reviewed the general ledger, tax returns, and other internal records and found that they did not agree with each other.
To reconcile the books, we initiated a 10-year lookback — correlating the firm’s capital accounts to their internal records and tax returns. We then established procedures to ensure that, moving forward, all records are properly checked and reconciled.
A fledgling publisher was struck a seemingly fatal blow when a rival hired away its best writers and artists. Not yet profitable, the publisher saw no way to prove that the theft of personnel had in effect stolen the company's future. The defense's position was simple. No harm, no foul — you can't lose money you never made. Or can you?
The case was turned down by other firms who saw no avenue to a solution. Berdon set aside the conventional and sought a different way to grapple with this dilemma. We adapted a rare approach from intangible asset theory for our damage model.
Our results demonstrated that the rival's raid had a measurable impact on the development of the publisher's business — delaying profitability. Our rationales and valuations were recognized by the court, and damages were awarded.
Unsupervised, the investment firm strayed far afield — gambling with risky, highly questionable investments. An internal audit highlighted suspected problems and revealed that vital information had disappeared.
Moving quickly, our forensic investigators stepped in to interview key figures, reassemble emails, and employ sophisticated software and other forensic techniques to recreate 18 months of data. We illustrated how every transaction fit into a calculated scheme. The bank was able to prove fraud and recoup a major portion of its loss.
Concerned about his decreased net worth caused by the economic downturn, our client wanted a measure of how much money he had gifted to his children over the last 10 years. Rather than provide this prominent real estate entrepreneur with a simple snapshot of his past gifting, we took it a step further.
We developed a model that projected the value his gifting would bring his children annually over many years to come — well into their middle age. To his surprise, the gifting had the potential for a total payout of $100,000,000! Now realizing that he had already provided his children with a strong financial future, he was able to shift the money he had been giving them towards his own current and future needs.
When it comes to your finances, no plan should ever be set in stone … or you may end up with results you never intended. It was a lesson Henry learned after changes to the estate and gift tax laws went into effect for 2011 and 2012.
In 1997, when Henry was in his mid-40s, he had a will drawn up designating that upon his death any amount that could be transferred to his children free of federal estate tax should go to them, with the remainder going to his wife. This kind of planning was not uncommon for a time when the federal unified estate and gift tax exemption was only $600,000 and hardly changed from year to year.
After taking a deeper look at his will in light of 2011 tax law, Henry was shocked to find that his current will would leave almost nothing to his wife. Over the years, his modest estate had grown to just over $5 million, and under today’s law, the unified federal estate and gift tax exemption had risen to $5 million. This meant that his children would be entitled to the bulk of his $5 plus million estate, leaving his wife with little to live on.* Henry faced an outcome that was not at all what he had intended.
Launching into action, Henry was presented with several options to mitigate this flaw and chose one that best fit his original intentions. His mind is now at ease, knowing that both his wife and children will be well taken care of in the way he had envisioned and in the most tax efficient way.
*Although the will can be challenged after death, the process is usually costly and time consuming, and the desired outcome is not certain.
It seemed straightforward. A financial advisor had a deceased client with an estate and foundation as beneficiaries. The trouble was the deceased had not filed tax returns for the previous seven years.
Adding further complexity, the estate contained real estate and there were issues with past gift tax returns and a worker’s compensation audit.
Berdon specialists navigated the real estate issues and resolved the gift tax and audit questions. Skilled at uncovering and reassembling years of tax data, we filed the missing returns and negotiated ways to minimize the penalties for failing to file the returns. By coordinating the skills of our various specializations we were able to move swiftly to deliver the maximum benefits to the estate and foundation.
The patriarch of the business had passed away and the eldest son, also the trustee, wanted to buy out his siblings. He needed to be released as trustee, which required an accounting of trust activity. One trust dated back nearly 40 years and another was almost 50 yearsold. In total, more than 200 years of trust activity needed to be accounted for. Unfortunately, the trust records were fragmentary and some of the individuals involved had died — leaving gaps and whole years missing. The situation stalled the business and bred ill-will among the siblings with the potential for legal action.
Working closely with the family’s attorneys, Berdon fiduciary accountants reassembled the past. To fill in the gaps, Berdon examined the financial statements of the various trusts’ assets and reviewed decades of tax returns. Boxes of records were identified, recovered, and reviewed. Diplomatic skills were required to obtain information from individuals who were reluctant or slow in complying. Using existing records as pointers, the trusts’ activities over the years took shape.
Our results enabled the business to move forward, satisfied all the siblings, and provided a more economic and swifter termination of the trusts than a court settlement.
The year is 2007 and Frank has assets, mostly real estate, valued at $250 million, a lot of which he would like to set aside for future generations. To better manage the real estate holdings, he transfers them to an LLC. The recession takes its toll, and by 2010 those same assets are depressed in value, worth a little more than $150 million. Now, in 2011, the estate and gift tax laws have changed, bringing the lifetime gift exemption up to $5 million. Unexpectedly, the law left valuation discounts untouched, while interest rates are still at historic lows.
All of these factors — low asset values, increased gift tax exemptions, valuation discounts, and low interest rates — combine to create a tremendous wealth transfer opportunity that may not come again in Frank’s lifetime! The following gives you a taste of the power of this opportunity — which can work for individuals with higher or lower net-worth and many different types of assets.
ONE | CREATE A GENERATION SKIPPING GRANTOR TRUST
Frank creates a Generation Skipping Grantor Trust for the benefit of his three children and future grandchildren, which will ultimately hold a 49% (roughly $75 million) membership interest in the LLC, and therefore be considered a noncontrolling interest. This sets the stage.
TWO | TAKE VALUATION DISCOUNTS
A well-structured gift or sale of a noncontrolling interest in the LLC may be entitled to a discount of 30% to as much as 50% for minority interest and lack of marketability. (That minority discount was nearly eliminated in a 2010 tax bill.) Based on a qualified appraisal of the 49% interest in the LLC, the combined discount is determined to be 40%. This dramatically trims the value of the $75 million LLC interest down to around $45 million... and this is just the beginning.
THREE | REAP THE BENEFIT OF INCREASED GIFT TAX EXEMPTION
For 2011 and 2012, the Gift Tax exemption is raised from $1 million to $5 million. Since Frank had not yet used the previous $1 million exemption, he was able to gift a $5 million LLC interest to the Trust free of gift tax, which can be further leveraged to yield far greater amounts.
FOUR | FINANCE ASSET SALES TO THE TRUST WITH HISTORICALLY LOW INTEREST RATES
Frank can then sell a $40 million interest to the trust, financing the sale at a very low interest rate — the Applicable Federal Rate (AFR), which in April 2011 is under 2.5% on an interest-only 9-year promissory note. This $40 million sale along with the $5 million gift adds up to a transfer of $45 million to the trust, a 49% noncontrolling interest in the LLC. And there’s still more...
FIVE | TAX ADVANTAGES MOUNT
Any future appreciation on the transferred interest and any income in excess of the interest on the note will accrue to the benefit of the trust and will not be subject to estate tax. As an added bonus, since a Grantor Trust was used, there will be no capital gain at the time of sale. To top it off, Frank pays the income taxes on the income earned by the Trust even though the income accrues for the benefit of the children and grandchildren.
A STRIKING RESULT
By transferring a minority interest, Frank is able to immediately place up to $75 million of assets in a trust, subject to the $40-million note, for the benefit of his children and grandchildren — without paying any gift tax. If the real estate doubles in value by 2019 and Frank were to pass away soon after, the astounding result could be more than $55 million in estate tax savings, with over $120 million in trust for his children and grandchildren. And…
Since the Trust is structured as a Generation Skipping Trust, the assets can pass on to future generations estate tax free. Left alone over the decades and moving from generation to generation barely touched by estate taxation, the assets can appreciate for 10, 20, 50 years and more! But there is a pivotal time limit — a key condition that allows this extraordinary strategy to work so well is set to expire at the end of 2012.
A major real estate entrepreneur was ready to sell a highly leveraged commercial property he had in his portfolio for years. The buyer was ready, the price was right, but the tax cost would have been intolerable. We devised an arrangement, involving a lease and a loan, that mirrored the benefits of a sale without incurring current taxation.
Four high-profile real estate families had varying partnership interests in a group of 26 hotels across the U.S. We saw that benefits would accrue if ownership could be melded into one entity, creating a blended ownership percentage for each family. The cloud over this already complex transaction was a substantial reduction of the hefty multimillion-dollar depreciation allowance they enjoyed. We transferred ownership of the hotels to one entity over a three-year period — achieving the desired ownership from day one of the transfer and precluding any loss of depreciation.
Our client was presented with a multipart commercial real estate package. We dug in, dissected the numbers, and viewed the deal from a myriad of angles. Our answer was a no go. Most would stop there, but for Berdon it was the starting point to see what lay below the surface. We identified a single element of the deal — a short-term leasehold — that would clearly be a boon for our client. At first blush, others might have overlooked this gem. We saw the beauty in the opportunity and the profitability for our client.