Financial Planning Foul-Ups

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Without going into all of the complexities of this case, your buy/sell agreement should be written and reviewed by a qualified tax attorney who specializes in this type of planning. Far too often I see agreements written by the owners from some software they purchased, or by attorneys whom the clients know and trust. but who specialize in another form of law.

M,rro*r 5 (ontemplation of Divorce

With an estimated 50Vo of all marriages in the U.S. ending in divorce, don't you think it wise to draft your buy/sell agreement in contemplation of this situation? This problem can get even worse when it is a family business and a shareholder gets divorced. Absolutely nothing is held back, and the litigation expense is only part of the problem.

I encountered one family-owned business where one son had three (yes, three) ex-wives working in the company. And he was actually married a fourth time (she refuses to work at this companyl). The courts will not allow fbr the penalization of a former family member (e.g., the purchase price for stock of ex-in-laws is lOVo of that of any other family member). You can, however, build a requirement that only employees, officers and directors are allowed to own shares. If the ex-inlaw is not elected to the board, then he/she would be required to sell the shares back to the company.

Mrsrue 6 Loss of tax basis

This is the reason most business owners should use corporate cross purchase agreements rather than stock redemption agreements.

In redemption arrangements, the corporation simply redeems the stock and it then becomes treasury stock and does not provide any income tax basis adjustment to the remaining owners. If an insurance policy is involved and the corporation owns the contract to then redeem the stock to benefit the deceased shareholders family, they may not see a dime of the proceeds if a large bank loan is outstanding (see Mistake l).

With a properly written and executed cross-purchase agreement, the surviving shareholder uses the proceeds from the insurance to "buy" the shares from the decedent's spouse, resulting in a full step up in cost basis for the shares purchased. This can result in a huge tax-savings for the surviving shareholder(s) ifthe stock is later sold.

M'srur 7 Personal guarantees

Most small business owners are required to guarantee most commercial lines of credit and company liabilities. This happens far too often, due to the owner not understanding the "rules of engagement." I helped a client renegotiate her lines of credit and was able to remove the requirement for her personal guarantee (had to change banking relationship to do it when primary refused to remove the personal guarantee) and in the process saved her thousands ofdollars in interest expenses.

In another situation. the father had transferred controlling interest of his company to his children and was surprised to learn that the bank still required his personal guarantee.

Mrsrxe 8 Intra-family sales

The Internal Revenue Code allows for the IRS to totally ignore unrealistic valuations in intra-family transactions. This goes back in part to the Blount TC memo in Mistake 4, when you agree to a buyout price that differs materially from the actual FMV at death. This could spell certain financial disaster to an otherwise thriving enterprise. This is another great example as to why special care must be taken into account when draftine vour buy/sell agreement.

M,rro*r 9

Slate income taxes

This is an example of the good, ol' tax system at work. With all of the budget deficits at the state and federal level, state governments are now stepping up enforcement of tax collection of out-of-state owners on S corporation distributions. Some states even go so far as to only recognize the S election if all recognized owners pay state income taxes on their share of the S corporation earnings.

Your tax professional should be keeping you up to date on this if this applies to you.

Mrsraxr 10

Block sales

This refers to the "right of first refusal" in every well-drafted buy/sell agreement. Every owner has a right to exercise the right of first refusal. Those owners who don't exercise the right defer their rights to other owners. As a result. a minority owner can dictate terms to all owners or delay the transaction until all owners go through the various rights of first refusal notices.

It is important to note that this does not require the minority owner to sell his or her shares. No business owner would ever want a minority owner to hold up a possible sale.

Moto*r 11

Dixounts on minority interests

As a business owner, you are well aware of the value of majority interests vs. minority interests in any company. Ask yourself this question, "What's the difference in value of a successful enterprise of a 5l%o interest vs. a 49Vo stake?" Answer: a lot more than 2%ol So with this in mind, should the 497o owners' shares be valued the same on a per-share basis as the 5l7o owner? This should be spelled out in the agreement so as to avoid any conflict or misinterpretation on this point.

Mot*.12

Tax distributions

Many business owners fail to rec-

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DOMESTIC

Long, Michael Parrella, Bruce Keith, Janet Pimentel, Pete Ulloa, George Parden, Vince Galloway, Steve Batick.

Oscar Portillo.