All in the Family - financial planning

Can your clients be too focused on the bottom line?

THEY CAN IF ATTENTION TO BUSINESS operations causes them to neglect planning for the orderly transfer of family wealth.

Succession planning often plays second fiddle in family-owned businesses: It doesn't add anything to the bottom line. It forces a discussion of senior family members' mortality and role in the business' day-to-day operations. It can raise issues of control, cash flow, family preferences and many other sensitive or uncomfortable issues. It also can carry perceptions of being unnecessary, time consuming, complicated or expensive.

For clients who want to address succession planning, you can play a pivotal role as their CPA and trusted adviser. Your long-term relationships with your clients, particularly family-owned business clients, and your intimate knowledge of the business' financial well-being make you the perfect "partner." Your knowledge of historical facts and transactions, as well as records, may put you in a position to make recommendations that could result in savings of hundreds, thousands or millions of dollars.

PRIMARY CONCERNS

A comprehensive succession plan includes both tax and non-tax considerations. Tax planning includes techniques designed to reduce income taxes, as well as estate, gift and generation-skipping transfer taxes. Non-tax considerations in a succession plan include compensation, cash flow and control.

An overarching question to address at the outset is: What is the long-term plan for the family business? To truly delve into the issue, you'll want to ask additional probing questions such as:

* Is it likely that the business will be sold? If so, succession planning should take a back seat to income tax and estate tax planning.

* Does the company have sufficient capital to operate for the long term, or will it be necessary to align with a financial partner to achieve the company's goals?

* What family members are included as part of the succession in management?

* Have senior family members discussed how to handle those family members who are not actively involved in the business?

* Are non-family members involved in the business?

* What incentives are needed to induce non-family members to remain with the company long term?

While it is impossible to predict the future, work with your clients to try and obtain answers so they have a clear understanding of how different issues relate to the long-term transition of a family business' management and ownership.

EVALUATING THE INTANGIBLE

Certain intangible factors should be evaluated as well:

* How do the business owners feel about their role in the company as management responsibilities, ownership and compensation levels change?

* Are senior members afraid to lose control?

* How will the changes affect the relationships among the members of the next generation?

While there may not be concrete answers to these questions, they should not be ignored. The potential emotional and sometimes difficult issues inherent in these questions may be why succession planning is avoided.

THE DIGGER PICTURE

Another core consideration is: How will a succession plan work within the context of the client's overall estate plan?

You'll need to verify that the client has an up-to-date estate plan. By reviewing tax-reporting information you can determine whether or not all of the client's assets have been transferred to a living trust and if any of the entities have changed ownership. You'll want to gauge if the estate plan's terms are consistent with the owner's desire for succession planning.

IDENTIFY THE NEED FOR HELP

Once you and your client have explored big-picture issues and determined that succession planning may be desirable, you'll need to call upon others' expertise. A well-designed succession plan will likely involve other professionals such as an attorney, appraiser and insurance agent. If your client has issues about losing control, family counselors or psychologists may help ease this transition.

You should act as your client's representative to ensure that all of the professionals' efforts are coordinated and that erroneous assumptions and incorrect conclusions are avoided.

Succession planning can be structured in numerous ways depending upon the client's situation. Generally speaking, keep it very simple. Complexity can lead to confusion, misunderstandings, mistakes and unanticipated consequences. Moreover, there is a direct relationship between the plan's complexity and cost and its likelihood of implementation. Also, the more complicated the plan, the greater likelihood that the client will not recall, even a few months later, the plan's basics or purpose.

STRATEGICALLY SPEAKING

As most professionals now understand, the recently enacted estate tax repeal means that there is no estate tax repeal. The amount that can be transferred upon death tax-free is scheduled to increase to $3.5 million dollars per decedent by 2009. After that, the estate tax is repealed for one year, and then the repeal is repealed after 2010.

A conservative approach is to assume that after the repeal's repeal, Congress will at least provide credit amounts similar to the 2009 limits. While this will relieve the tax burden for certain closely held businesses, several non-tax issues remain. For closely held businesses valued at amounts substantially in excess of $3.5 million dollars (or $7 million dollars for a married couple), the tax consequences still will play an important role in estate planning.

TAX PLANNING TRADEOFFS

Most succession-related tax planning involves tradeoffs in areas such as cash flow, control and complexity. For example, a client may be willing to sacrifice a certain amount of income or control to achieve a desired tax result. Or a client may be willing to sacrifice the optimum tax result to retain income. The key is helping the client identify these tradeoffs and come to an educated understanding of the benefits and costs.

A common concern among wealthy clients is that their children will not become productive individuals if they obtain extraordinary wealth too easily and before they are emotionally ready to manage it. An outright transfer of ownership of a family business to children can have adverse consequences for the other business owners if the child later divorces or has other creditors. This important concern must be addressed with tax planning.

Often, the professionals who assist in succession planning are not regularly involved with the client. However, as the client's CPA, you usually have regular, ongoing contact. As such, you must ensure that the client thoroughly understands the tax plan and related consequences. It's not enough for your client to hear the explanation and nod affirmatively or, even worse, say to you or other professionals, "I leave it up to you."

Knowing the client's personality and risk tolerance levels can help you anticipate what makes the most overall economic sense for your client. For example, will the client be frustrated by a new ownership structure that he does not completely understand? Or will the client resent the additional fees and costs incurred to maintain the entities that were created to implement the tax plan? Thoroughly discuss and confirm in writing all aspects of the succession plan.

Most succession tax planning results in the creation of new entities with tax filing obligations. You will need to incorporate all entities as part of the annual income tax plan and track the due dates for filing tax returns. The client should understand and be prepared for the additional tax filing obligations.

INSURANCE

For many clients, the mere utterance of "life insurance" enlists a vigorous negative response. However, its tax advantages, combined with the assurance of liquidity at precisely the time it is needed, make life insurance an important part of a succession plan.

For example, life insurance often is used to fund the buyout of a partial owner of a family business and to pay estate taxes. Essentially, it is an investment, similar to purchasing bonds that mature upon the insured's death.

As your client's CPA, you can introduce the insurance agent to the planning process and coordinate the life insurance purchase with the overall estate and succession plans. You also can perform the financial analysis relating to the life insurance purchase and explain its benefits to your client.

BUY/SELL AGREEMENTS

Whenever there are multiple owners of a business, a buy/sell agreement often is essential for a smooth transition. Without a buy/sell agreement, the potential for disputes, conflicts and deadlock increases dramatically.

Too often, clients view a buy/sell agreement as a standard form agreement that can he quickly generated on a computer. Instead, the client needs to understand the other business owners' possible rights in the event of death, disability, termination of employment and divorce. When your client wants to memorialize these issues or arrange a buyout of a current owner, you play a valuable role in assisting with the agreement's specifics by determining the value of business interests and the manner in which interests are acquired.

THE CPA AS SUCCESSOR TRUSTEE

Unless a client leaves assets outright to adult beneficiaries upon death, the client needs to appoint a successor trustee to hold and administer trust assets. Your client may consider naming you as a successor trustee. Before accepting, consider the following:

* You should have the requisite expertise to act as a trustee. A trustee has a wide range of responsibilities that require different services than a CPA customarily provides.

* Your firm may lose its independence or have other potential conflicts of interest.

* There is a risk of potential liability to disgruntled beneficiaries. It is unlikely that malpractice insurance would cover a CPA's negligent conduct as a trustee. Moreover, the cost of errors and omissions insurance for a trustee can be very expensive.

* The overall cost to the beneficiaries of having a CPA (or other individual) serve as trustee may be higher than other alternatives. In addition to the trustee and accounting fees paid to the CPA, there also will be substantial attorney fees, at least during the initial administration of the trust, as well as investment advisory fees.

To avoid some or all of these potential problems, you should discuss the possibility of naming a financial institution or trust company to serve as sole trustee, or as co-trustee. Professionally managed trust companies provide trust administration services and expertise that are required to properly administer the trust, thereby reducing the costs incurred for legal fees and other administrative services. The institution's fees also may include investment advisory services that the trust would otherwise separately incur.

To allay any concerns a client might have about saddling the beneficiaries with an unresponsive institutional trustee, the trust instrument can give you or the beneficiaries the right to replace one institutional trustee with another.

REVIEW AND COORDINATION OF THE DOCUMENTATION

The various documents that should be prepared and executed in connection with both estate and succession planning typically are lengthy. While you don't need to read every word of every document, there are critical sections of each document that you and your client should read carefully and understand. A careful reading with the client will reveal the depth of the client's understanding, or lack thereof.

There should be at least one, and if possible two or three, meetings in which all of the professional advisers meet with the client to review the plan and documentation. You can act as a facilitator to ensure that the client understands and approves the plan. Knowing that you have approved all aspects of the succession plan will give your client more confidence to make decisions.

Don't underestimate your importance in succession planning. You are in the best position to know when it is needed. And since succession plans are not static documents, you can make yourself invaluable to your clients by monitoring their plans and recommending necessary changes.

The value added from a well-conceived and executed succession plan is immeasurable. A few relatively simple and straightforward suggestions can result in substantial tax savings to family members. More importantly, proper planning can reduce the stress and anxiety resulting from a death, disability or retirement of a founding owner.

William M. Weintraub, Esq. and Valerie B. Schultz, Esq. are attorneys in the tax department of the Los Angeles-based law firm of Jeffer, Mangels, Butler & Marmaro LLP. They can be reached at wmw@jmbm.com and vbs@jmbm.com.

COPYRIGHT 2001 California Society of Certified Public Accountants
COPYRIGHT 2001 Gale Group