Ch20 - Transferring The Closely Held Business

Question 1

Valuation discounts are used when the value determined by one of the valuation methods is greater than the actual current market value. Describe the following reasons for the disparity.

(1) lack of control discount
(2) lack of marketability discount

Answer 1

(1) lack of control discount - the inability to control the business (eg - minority discount)
(2) lack of marketability discount - a lack of marketability of a closely held business interest because it has generally never been offered for sale to outsiders

Question 2

What is the purpose of a corporate buy-sell agreement? (4)

Answer 2

1) Creates guaranteed market in case of death, disability, or retirement
2) Provides liquidity for shareholder’s retirement or estate
3) Establishes purchase price
4) Assures no outsiders purchase the business

Question 3

What will make a Grantor Retained Annuity Trust (GRAT) the most effective for federal estate tax purposes of a closely-held business owner? Why?

Answer 3

If the grantor survives the trust term and passes the remainder interest of the annuity at death. This is because the business interest will be excluded from the estate of the grantor and might qualify for possible valuation discounts for gift tax purposes.

Question 4

How long can Sec. 6166 installment payment of estate tax be deferred?

Answer 4

It can be deferred until the death of the second spouse and then deferred in part for an additional 15 years, but NOT the estate’s administration expenses.

Question 5

What are the THREE disadvantages of electing the Sec. 6166 installment payments of estate taxes?

Answer 5

1) buy-sell agreement cannot be used with this arrangement
2) the estate remains open until all taxes paid
3) it’s a cash drain on the business

Question 6

Unlike an installment note, when is the gain in a business being sold using a private annuity recognized?

Answer 6

immediately

Question 7

An installment sale is a sale in which at least one payment is received in the year after the sale. What are the FOUR advantages of an installment sale of a closely held business interest to family successors?

Answer 7

(1) there are no gift tax consequences.
(2) payments received are part interest income, part capital gain, and part return of capital
(3) sale removes future appreciation from the estate
(4) at the seller’s death, the present value of future payments will be included in the gross estate

Question 8

This is a sale of a family business, in exchange that the purchaser makes periodic payments of a specified sum until the death of the seller, where it will not be included in the seller’s estate.

Answer 8

private annuity

Question 9

What happens at the time of owner’s death, when using a buy-sell agreement?

Answer 9

The owner’s distributive share of income is added to the descendent’s estate. If the payments exceed the estate’s basis in the business, then the additional amount is considered capital gains, and taxed as ordinary income. The purchasing owners will have an increase in their basis equal to the amount purchased from the deceased business owner’s estate.

Question 10

What are THREE problems in transitioning to a business owner’s retirement?

Answer 10

1) Identify and groom an appropriate successor(s)
2) Giving the successor(s) a gradually increasing role in business decision making
3) Coordinate business transition with estate plan/buy-sell agreement

Question 11

What are those FOUR choices for transferring (or sale) the business to successors during life and at death?

Answer 11

1) Sale of a controlling interest to successors (life)
2) Gift to family successors (life)
3) Sale through buy-sell agreement (death)
4) Testamentary bequest to family successors (death)

Question 12

The owner will probably expect the business to provide his or her continuing family needs during retirement. What are the FIVE choices for providing post-retirement income to a business owner?

Answer 12

1) benefits from a qualified and non-qualified retirement plans
2) payment for continued services (eg - consulting)
3) proceeds from the sale of the business
4) passive income from retained ownership
5) business owner’s other accumulated wealth

Question 13

When the current owner of a closely held business prepares to turn over the business to successors, what are FOUR estate planning objectives that should be considered?

Answer 13

a) retaining assets that provide adequate retirement income while minimizing the size of the taxable estate
b) transferring control and future appreciation of the business to the appropriate successors
c) planning adequate liquidity for the estate
d) arrange for an orderly and equitable distribution of nonbusiness assets

Question 14

Some of the business owner’s children will probably not become actively involved in the a closely held business. What is recommended for business owners who want to leave their estates equitable to heirs?

Answer 14

a) purchase an Irrecoverable Life Insurance Trust (ILIT) to provide for nonparticipants
b) accumulate assets outside the business
c) sell business at full value to successors and distribute proceeds to heirs

Question 15

What are the FIVE problems that prevent a successful transfer to a successor?

Answer 15

a) Inadequate or poorly communicated business transition plan
b) Lack of coordination or forethought in the plan
c) Insufficiently trained successors
d) Conflict between current owners and successors
e) Stagnation in the business due to harvesting

Question 16

For simplicity, most planners estimate the administrative and settlement expenses as _____% of the value of the estate.

Answer 16

2-5% of the estate

Question 17

IRS regulations describe substantiation requirements to ensure the protection of the 3-year statute of limitations and provide enough information regarding the nature of the transaction. What are the THREE requirements?

Answer 17

a) complete description of the property
b) _valuation method_s and supporting information for discounts
c) property appraisals serve as substantiation

Question 18

This technique is available in circumstances when a donor of property would prefer to retain a temporary interest in a trust while giving the remainder away to family members (or a trust for family members).

Answer 18

Grantor Retained Annuity Trust (GRAT)

Question 19

What happens if the seller dies during a Sec. 6166 installment sale of a closely held business interest to family successors?

Answer 19

Any future payments are included in the gross estate of the seller.

Question 20

What is a Self-Cancelling Installment Notes (SCINs)?

Answer 20

If the seller dies during installment term, future payments cancel at death and will NOT be included in the gross estate.

Question 21

The buy-sell agreement for corporations can provide for either __________ or __________.

Answer 21

(1) an option to buy
(2) the mandatory purchase of the deceased shareholder’s stock.

Question 22

What does Sec. 6166 tax provision allows an estate that contains closely held business interests to do?

Answer 22

Defer the payment of estate taxes caused by the business interest and be paid in 10 installments.

Question 23

Who is taxed on income from a Grantor Retained Annuity Trust (GRAT)?

Answer 23

the grantor, thus GRAT

Question 24

To qualify to defer estate tax payments under Sec. 6166, the estate must hold a closely held business interest valued at greater than ___\_% of the adjusted gross estate.

Answer 24

35%

Question 25

What is the interest rate on deferring Sec. 6166 installment payment of estate tax?

Answer 25

A favorable 2% interest rate

Question 26

Buy-sell agreements that are triggered by the death of the business owner are generally funded with __________.

Answer 26

life insurance

Question 27

Why are other methods used to fund a buy-sell agreement, such as a savings fund, will generally be inadequate?

Answer 27

Because it requires the company to set-aside of significant business assets and will generally be inadequate in the case of a premature death.

Question 28

What are the THREE advantages of funding a buy-sell agreement with life insurance?

Answer 28

a) liquidity is provided at time of need
b) the cost is manageable and predictable
c) there is favorable tax treatment of accumulation and death benefit

Question 29

In the case of an entity-type buy-sell agreement (aka - stock redemption) and a cross-purchase arrangement, how do these two approaches differ?

Answer 29

In the case of an entity-type buy-sell agreement, the business owns a policy on each owner, pays premiums, and is the beneficiary. In the cross-purchase arrangement, each owner purchase life insurance on the other owners and makes the premium payments

Question 30

A(n) __________ can be cumbersome and more expensive than a(n) ____________ with 3 or more owners.

a) entity-type buy-sell agreement
b) cross-purchase arrangement

Answer 30

A cross-purchase arrangement** can be cumbersome and more expensive than an **entity-type buy-sell agreement with 3 or more owners.

Question 31

What are the THREE benefits of an Irrevocable Life Insurance Trust (ILIT) to business owners?

Answer 31

a) indirectly provide liquidity for setting an estate by purchasing assets from estate and making loans to the estate
b) equalize estate distributions for nonparticipants in business
c) transfer outside probate