Tax-Efficient Business Exit Strategies

for both Thomas and his wife, while endowing a dynasty trust for future generations with the remaining death benefit.

About the Authors

Tim Voorhees, JD, MBA, is a principal partner at Matsen Voorhees Mintz LLP in Costa Mesa, CA. With more than 35 years of experience as an attorney and business planning adviser, Tim has helped clients save millions of dollars in taxes while transferring their legacy to their families and favorite charities. His book on tax-efficient planning is described at www.

ZeroTaxCounsel.com. Feel free to email Tim at tim@vfos.com.

Guy Baker, MBA, MSFS, MSM, was recently recognized as one of Worth Magazines’ top 250 advisers. Established in Orange County in 1970, Guy has built a financial service company serving the needs of business owners who are looking to have a trustworthy relationship to help them manage their Three Circles ofWealth.

Where do the Smith’s get the premium dollars?

Instead of taking the $5,000,000 from cash flow, the company can borrow all of the money needed for the above strategy. Thomas has no out-of-pocket costs for insurance. In a high tax state, most of the interest costs are funded with money that would have been lost to taxes. By signing appropriate disclosures, Thomas can have insurance professionals pay the few plan design, drafting, and funding fees. In short, Thomas can arrange for third parties to fund all legal and insurance costs for his plan. What Thomas pays out of pre-tax cash for interest is a small amount compared to the expected increase in after-tax retirement and death benefits.

What is the bottom line?

Advanced planning strategies allow business owners to fund business continuity plans more cost-effectively. Business owners should work with advisers who can design a plan that can convert extra taxable income into tax-free cash flow for retirement and/or the tax-free purchase of equity from the business owner’s estate. Once the plan has been designed, experienced attorneys will draft legal documents to facilitate the tax-efficient plan funding. This integration of design, drafting, and funding helps insure effective implementation of the strategy as well as proper realization of benefits under a variety of scenarios. A wise adviser can quantify how planning costs are just a small fraction of the expected benefits. More importantly, these financial benefits bring peace of mind to the business owner, his or her family, and key executives. Great clarity and confidence results from having a business continuity plan that has been designed properly, drafted effectively, and funded tax-efficiently.

Matsen Voorhees Mintz LLP 695 Town Center Drive, 7th Floor, Costa Mesa, CA 92626 Phone: 800-447-7090 or 949-878-9400 • Fax: 866-447-7090 Email: info@MVMLawyers.com Readers of this document should consult with independent advisers regarding the tax, accounting and legal implications of the proposed strategies before any strategy is implemented. Nothing in this presentation is intended to offer securities or investment advice. Above numbers are based on a hypothetical fact pattern. Tax and regulatory rules affecting strategies in this document may change often and have varying interpretations. To ensure compliance with requirements imposed by the IRS under Circular 230, we inform you that any U.S. federal tax advice contained in this communication is not intended or written to be used, and cannot be used, for the purpose of avoiding penalties under the Internal Revenue Code or for promoting, marketing or recommending to another party any matters addressed herein. This draft is dated 10/5/2013. The final published version may differ.

Tax-Efficient Business Exit Strategies Key Takeaways • Most business owners create unnecessary risks for their families, employees and clients by failing to fund business succession plans • Business owners can cut the costs of implementing succession plans in half by funding insurance programs with pre-tax dollars • Instead of paying top marginal tax rates of more than 50% on extra business income, it is possible to take deductions now to fund insurance policies that grow tax free and make tax-free payments during retirement and/or at death.

• When considering the tax benefits of business succession strategies on top of the investment returns in good insurance policies, it is often possible to generate double-digit internal rates of return • More important than the high after-tax IRRs is the peace of mind that comes from knowing that a business succession plan has been designed, drafted, and Tax experts can recommend various tax-deductible buysell strategies but Capital Split Dollar may be the most attractive for many business owners.

Business owners can work with advisers who can design a plan that can convert extra taxable income into tax-free cash flow

By Tim Voorhees and Guy Baker What motivates most business owners to think about a business succession plan?

Scary stories about failed companies motivate business owners to consider implementing a business succession plan. Despite the obvious need, few plans are actually designed, drafted, and funded properly. High professional fees and insurance costs often take the blame when business owners are asked why they did not implement a succession plan. To overcome these concerns, wise advisers will motivate business owners to complete their plans by showing them how to fund all costs with tax savings.

Why do so many succession plans miss the mark?

Most business succession plans fail. Only 30% of the businesses make it to generation two and a mere 3% survive to generate profits in generation three. Given this dismal success record for family business transitions, it is no wonder 65% of family wealth is lost by the 2nd generation and 90% by the third generation. By the third generation, more than 90% of estate value is lost despite the efforts of wellmeaning advisers. It does NOT have to be this way.

What is the biggest problem business owners face when they try to implement succession plans?

Unless business succession planning addresses tax issues, company owners can lose much of their wealth to income, capital gains, IRD, gift, estate, and other taxes. In most successful businesses, the company will generate taxable cash flow that exceeds what

An astute adviser knows how to fund business succession agreements in ways that generate current income tax deductions while allowing the business to generate tax-free income for the business owner and/or successors.

is needed to fund their lifestyle. This extra cash flow is then taxed at 50% or higher top marginal state and federal income tax rates. When the after tax proceeds are invested, the growth is subject to 30% or higher capital gains rates (when taking into account state tax rates, the Medicare surtax, and the phaseout of deductions). Ultimately, when the remaining assets are passed to family members or successor managers, there could be a 40% gift or estate taxes applied.

In short, Thomas can arrange for third parties to fund all legal and insurance costs for his plan.

ClimbTaxPyramid, qualified plans provide tax-deductions in the current years, but they are not typically as tax-inefficient for funding a buy-sell. More advanced planning strategies involving Section 79 and Section 162 plans can provide tax-free payments for the retiring executive or death benefits for family members, but limit the tax deductions when the plans are funded. There are very few options when an adviser seeks upfront tax deductions, tax-free growth, and tax-free payments to the business owner and/or the owner’s heirs.

At the top of the pyramid linked above is Capital Split Dollar (“CSD”).

How can advisers help solve this tax problem?

To help solve this problem, every business owner should envision a clear transition plan and look for ways to improve after-tax returns. Tax-efficient planning strategies are needed to guide decisions about daily operations and business exit strategies. An astute adviser knows how to fund business succession agreements in ways that generate current income tax deductions while allowing the business to generate tax-free income for the business owner and/or successors.

Can you give us an example of how CSD works?

Take Thomas Smith, a successful business owner, as an example. He wants to lower his taxes this year and create a well-funded business continuity plan for his partners and family. He sees the importance of monitoring cash flow projections to identify unnecessary taxable income. His business can generate $500,000 annually of taxable income, but he only needs $300,000 annually pretax, for lifestyle. The extra $200,000 is wasted income and will be taxed at more than a 50% top marginal rate unless additional planning is done.

What are some ways advisers can help reduce taxes?

There are many tax-advantaged business succession techniques that give business owners a competitive edge. As noted at http://tinyurl.com/

What can be done to mitigate the extra taxes?

Thomas’ advisers suggest a solution to reduce income, lower capital gains, estate, gift, and other taxes. The advisery team shows Thomas how to offset $200,000 of income with a $200,000 tax deduction using life insurance. By creating a tax deductible interest payment on a Capital Split Dollar loan, they can eliminate all of the unnecessary taxes.

Assuming interest costs are 4%, a $200,000 annual interest payment will support a $5,000,000 loan. Placed in a properly constructed life policy, the entire $5 million grows tax free and eventually provides tax free loan distributions at retirement or provides a tax-free death benefit to Thomas’ family. Thomas can lock in interest rates at 4% for 10 years while maintaining enough cash value in the policy to pay off the loan should interest rates start to increase. Because the loan has recourse to cash value in an insurance trust, the borrowed money does not have to appear as a liability on the balance sheet of Thomas’ company.

Climbing the Pyramid Enhances Tax Efficiency Taxes on Employee Withdrawals

Taxes on Contributions Minimal Tax on Contributions

6) Advanced Tax Efficient Lifetime Income Solutions Capital Split Dollar Charitable LLC Family Retirement Account

Minimal Withdrawal Taxes

Moderate Tax on Contributions

5) Specialized Plans with Tax Efficient Funding and Tax Free Withdrawals Super Clat Section 79 Plan Section 162 Plan

Moderate Withdrawal Taxes

Moderate Tax on Contributions

4) Specialized Plans with Pre-Tax Funding Partially Taxes Withdrawals Charitable Remainder Trust Gift Annuities Pooled Income Fund

Moderate Withdrawal Taxes

Moderate Tax on Contributions

3) Non-Qualified Deffered Comp SERPS 409(A) Plans Traditional Deferred Comp

Heavy Deferred Income Tax

Heavy Current Income Tax

2) Qualified Plans Profit Sharing Defined Benefit 401(K) 1) Traditional Compensation Heavily taxed with payroll taxes going in and ordinary income coming out

Heavy Withdrawal Taxes

Heavy Withdrawal Taxes

Heavy Withdrawal Taxes

What does $200,000 actually provide in benefits?

A policy with $5,000,000 of cash value will likely create a $15 million death Structured correctly, this death benefit can provide ample funds for successor managers (e.g., children) to buy the business from Thomas’ estate and leave the Smith family with $15 million of after-tax cash. If, however, Thomas lives to life expectancy or beyond, the cash value can provide tax-free income

An astute adviser knows how to fund business succession agreements in ways that generate current income tax deductions while allowing the business to generate tax-free income for the business owner and/or successors.

is needed to fund their lifestyle. This extra cash flow is then taxed at 50% or higher top marginal state and federal income tax rates. When the after tax proceeds are invested, the growth is subject to 30% or higher capital gains rates (when taking into account state tax rates, the Medicare surtax, and the phaseout of deductions). Ultimately, when the remaining assets are passed to family members or successor managers, there could be a 40% gift or estate taxes applied.

In short, Thomas can arrange for third parties to fund all legal and insurance costs for his plan.

ClimbTaxPyramid, qualified plans provide tax-deductions in the current years, but they are not typically as tax-inefficient for funding a buy-sell. More advanced planning strategies involving Section 79 and Section 162 plans can provide tax-free payments for the retiring executive or death benefits for family members, but limit the tax deductions when the plans are funded. There are very few options when an adviser seeks upfront tax deductions, tax-free growth, and tax-free payments to the business owner and/or the owner’s heirs.

At the top of the pyramid linked above is Capital Split Dollar (“CSD”).

How can advisers help solve this tax problem?

To help solve this problem, every business owner should envision a clear transition plan and look for ways to improve after-tax returns. Tax-efficient planning strategies are needed to guide decisions about daily operations and business exit strategies. An astute adviser knows how to fund business succession agreements in ways that generate current income tax deductions while allowing the business to generate tax-free income for the business owner and/or successors.

Can you give us an example of how CSD works?

Take Thomas Smith, a successful business owner, as an example. He wants to lower his taxes this year and create a well-funded business continuity plan for his partners and family. He sees the importance of monitoring cash flow projections to identify unnecessary taxable income. His business can generate $500,000 annually of taxable income, but he only needs $300,000 annually pretax, for lifestyle. The extra $200,000 is wasted income and will be taxed at more than a 50% top marginal rate unless additional planning is done.

What are some ways advisers can help reduce taxes?

There are many tax-advantaged business succession techniques that give business owners a competitive edge. As noted at http://tinyurl.com/

What can be done to mitigate the extra taxes?

Thomas’ advisers suggest a solution to reduce income, lower capital gains, estate, gift, and other taxes. The advisery team shows Thomas how to offset $200,000 of income with a $200,000 tax deduction using life insurance. By creating a tax deductible interest payment on a Capital Split Dollar loan, they can eliminate all of the unnecessary taxes.

Assuming interest costs are 4%, a $200,000 annual interest payment will support a $5,000,000 loan. Placed in a properly constructed life policy, the entire $5 million grows tax free and eventually provides tax free loan distributions at retirement or provides a tax-free death benefit to Thomas’ family. Thomas can lock in interest rates at 4% for 10 years while maintaining enough cash value in the policy to pay off the loan should interest rates start to increase. Because the loan has recourse to cash value in an insurance trust, the borrowed money does not have to appear as a liability on the balance sheet of Thomas’ company.

Climbing the Pyramid Enhances Tax Efficiency Taxes on Employee Withdrawals

Taxes on Contributions Minimal Tax on Contributions

6) Advanced Tax Efficient Lifetime Income Solutions Capital Split Dollar Charitable LLC Family Retirement Account

Minimal Withdrawal Taxes

Moderate Tax on Contributions

5) Specialized Plans with Tax Efficient Funding and Tax Free Withdrawals Super Clat Section 79 Plan Section 162 Plan

Moderate Withdrawal Taxes

Moderate Tax on Contributions

4) Specialized Plans with Pre-Tax Funding Partially Taxes Withdrawals Charitable Remainder Trust Gift Annuities Pooled Income Fund

Moderate Withdrawal Taxes

Moderate Tax on Contributions

3) Non-Qualified Deffered Comp SERPS 409(A) Plans Traditional Deferred Comp

Heavy Deferred Income Tax

Heavy Current Income Tax

2) Qualified Plans Profit Sharing Defined Benefit 401(K) 1) Traditional Compensation Heavily taxed with payroll taxes going in and ordinary income coming out

Heavy Withdrawal Taxes

Heavy Withdrawal Taxes

Heavy Withdrawal Taxes

What does $200,000 actually provide in benefits?

A policy with $5,000,000 of cash value will likely create a $15 million death Structured correctly, this death benefit can provide ample funds for successor managers (e.g., children) to buy the business from Thomas’ estate and leave the Smith family with $15 million of after-tax cash. If, however, Thomas lives to life expectancy or beyond, the cash value can provide tax-free income

for both Thomas and his wife, while endowing a dynasty trust for future generations with the remaining death benefit.

About the Authors

Tim Voorhees, JD, MBA, is a principal partner at Matsen Voorhees Mintz LLP in Costa Mesa, CA. With more than 35 years of experience as an attorney and business planning adviser, Tim has helped clients save millions of dollars in taxes while transferring their legacy to their families and favorite charities. His book on tax-efficient planning is described at www.

ZeroTaxCounsel.com. Feel free to email Tim at tim@vfos.com.

Guy Baker, MBA, MSFS, MSM, was recently recognized as one of Worth Magazines’ top 250 advisers. Established in Orange County in 1970, Guy has built a financial service company serving the needs of business owners who are looking to have a trustworthy relationship to help them manage their Three Circles ofWealth.

Where do the Smith’s get the premium dollars?

Instead of taking the $5,000,000 from cash flow, the company can borrow all of the money needed for the above strategy. Thomas has no out-of-pocket costs for insurance. In a high tax state, most of the interest costs are funded with money that would have been lost to taxes. By signing appropriate disclosures, Thomas can have insurance professionals pay the few plan design, drafting, and funding fees. In short, Thomas can arrange for third parties to fund all legal and insurance costs for his plan. What Thomas pays out of pre-tax cash for interest is a small amount compared to the expected increase in after-tax retirement and death benefits.

What is the bottom line?

Advanced planning strategies allow business owners to fund business continuity plans more cost-effectively. Business owners should work with advisers who can design a plan that can convert extra taxable income into tax-free cash flow for retirement and/or the tax-free purchase of equity from the business owner’s estate. Once the plan has been designed, experienced attorneys will draft legal documents to facilitate the tax-efficient plan funding. This integration of design, drafting, and funding helps insure effective implementation of the strategy as well as proper realization of benefits under a variety of scenarios. A wise adviser can quantify how planning costs are just a small fraction of the expected benefits. More importantly, these financial benefits bring peace of mind to the business owner, his or her family, and key executives. Great clarity and confidence results from having a business continuity plan that has been designed properly, drafted effectively, and funded tax-efficiently.

Matsen Voorhees Mintz LLP 695 Town Center Drive, 7th Floor, Costa Mesa, CA 92626 Phone: 800-447-7090 or 949-878-9400 • Fax: 866-447-7090 Email: info@MVMLawyers.com Readers of this document should consult with independent advisers regarding the tax, accounting and legal implications of the proposed strategies before any strategy is implemented. Nothing in this presentation is intended to offer securities or investment advice. Above numbers are based on a hypothetical fact pattern. Tax and regulatory rules affecting strategies in this document may change often and have varying interpretations. To ensure compliance with requirements imposed by the IRS under Circular 230, we inform you that any U.S. federal tax advice contained in this communication is not intended or written to be used, and cannot be used, for the purpose of avoiding penalties under the Internal Revenue Code or for promoting, marketing or recommending to another party any matters addressed herein. This draft is dated 10/5/2013. The final published version may differ.

Tax-Efficient Business Exit Strategies Key Takeaways • Most business owners create unnecessary risks for their families, employees and clients by failing to fund business succession plans • Business owners can cut the costs of implementing succession plans in half by funding insurance programs with pre-tax dollars • Instead of paying top marginal tax rates of more than 50% on extra business income, it is possible to take deductions now to fund insurance policies that grow tax free and make tax-free payments during retirement and/or at death.

• When considering the tax benefits of business succession strategies on top of the investment returns in good insurance policies, it is often possible to generate double-digit internal rates of return • More important than the high after-tax IRRs is the peace of mind that comes from knowing that a business succession plan has been designed, drafted, and Tax experts can recommend various tax-deductible buysell strategies but Capital Split Dollar may be the most attractive for many business owners.

Business owners can work with advisers who can design a plan that can convert extra taxable income into tax-free cash flow

By Tim Voorhees and Guy Baker What motivates most business owners to think about a business succession plan?

Scary stories about failed companies motivate business owners to consider implementing a business succession plan. Despite the obvious need, few plans are actually designed, drafted, and funded properly. High professional fees and insurance costs often take the blame when business owners are asked why they did not implement a succession plan. To overcome these concerns, wise advisers will motivate business owners to complete their plans by showing them how to fund all costs with tax savings.

Why do so many succession plans miss the mark?

Most business succession plans fail. Only 30% of the businesses make it to generation two and a mere 3% survive to generate profits in generation three. Given this dismal success record for family business transitions, it is no wonder 65% of family wealth is lost by the 2nd generation and 90% by the third generation. By the third generation, more than 90% of estate value is lost despite the efforts of wellmeaning advisers. It does NOT have to be this way.

What is the biggest problem business owners face when they try to implement succession plans?

Unless business succession planning addresses tax issues, company owners can lose much of their wealth to income, capital gains, IRD, gift, estate, and other taxes. In most successful businesses, the company will generate taxable cash flow that exceeds what