Planning For Closely Held Businesses

Question 1

What are the tax treatment rules for closely held business stock redemption

Answer 1

The portion of the distribution not in excess of the corporations current accumulated earnings and profits is treated as dividends and taxed as ordinary income
Second the portion of distributions beyond corporate current and accumulated earnings is treated as a non-taxable return of capital/ basis.

Third, the portion of the distribution not treated as a dividend that exceeds the shareholders basis and his or her stock is tax is capital gain 

Question 2

What is IRS code section 6166

Answer 2

A relief provision to permit the deferral of estate tax payments.
Available to a US citizen or permanent resident.
Decedents whose closely held business, interest is more than 35% of their adjusted gross estate
in allows

Tax may be deferred for five years and there after paid in 10 annual installments.

Estate tax attributable to non-closely held business assets is due at the regular time, nine months from the decedents date of death 

Question 3

What is internal revenue code section 303 

Answer 3

Qualified redemptions of deceased shareholder’s stock may be treated as capital gain, instead of dividend income taxed as ordinary income.

Stock value must be greater than 35% of the adjusted gross estate.

Redemptions must be made within three years and 90 days from the due date of IRS form 706 (estate tax return) or 60 days after court decision if contested.

Question 4

What are qualified securities?

Answer 4

-Employer Security’s
-Issued by a C Corp.
-Not easily tradeable 1 year before and after the sale.
-Held by the seller for three years

Question 5

What is regulation 504D

Answer 5

Rule 504 of Regulation D provides an exemption from the registration requirements of the federal securities laws for some companies when they offer and sell up to $5,000,000 of their securities to any number of shareholders in any 12-month period

Question 6

Section 1042 says that taxable gain will not be recognized by a shareholder sale of stock to an ESOP if?

Answer 6

The shares are qualified securities

Immediately after the sell that ESOP owns at least 30% of the total value of all outstanding stock

and qualified replacement securities are purchased by the seller within a 15 month. Beginning three months before the sale date. 

Question 7

What are ESOP contribution deductibility rules? 

Answer 7

Contributions are deductible up to 25% of eligible compensation when used to repay principal on an ESOP loan.

Contributions used to repay interest on an ESOP loan are deductible to the employer, without regard to a compensation limitation.

Question 8

When considering an S corporation what item should be noted?

Answer 8

S corporation must have fewer than 100 shareholders.

Only one class of stock is allowed

Shareholder employees must be compensated with wages subject to withholding

Reasonable compensation must be paid to shareholder employees

Distribution of dividends must always be proportional to stock ownership

Non-US persons cannot be added as shareholders Nor can a current community property shareholder marry a non-US city

Question 9

What is mezzanine financing?

Answer 9

Mezzanine financing may be characterized by a hybrid type of security, junior to venture capital and senior to debt. It often requires little to no collateral, has an equity conversion feature in case of default.

Question 10

A family holding company is also sometimes called?

Answer 10

An asset holding company and is a method of recapitalization.
The FHC can issue, both voting preferred stock and nonvoting common stock, and it set up to manage the assets of another entity or entities.

Question 11

A LLC is normally treated like _________ for federal income tax purposes

Answer 11

Partnership 

Question 12

What has the flexibility of a partnership with the limited liability of a corporation?

Answer 12

Limited liability company 

Question 13

What provides a ready market for the sale of business interest, liquidity on a timely basis, and a smooth transfer to desired successors in the event of retirement, disability or death.

Answer 13

Buy sell agreement

Question 14

Which forms of company financing are considered restructuring?

Answer 14

Mergers, divestitures, recapitalization, and leveraged buyout.

A divestiture is a way to sell off a subsidiary business. A divestiture is the partial or full disposal of a business unit through sale, exchange, closure, or bankruptcy.

Question 15

On the topic of corporate redemptions and distributions, what is fair market value ?

Answer 15

Cash received, plus fair market value of property received, less liabilities

Question 16

In which strategy does the employee own the life insurance policy and cash surrender value while the employer is entitled to the death benefit?

Answer 16

Reverse, split dollar arrangement

Question 17

What is the value by which a corporations assets exceeds its liabilities, including contingent liabilities?

Answer 17

Book value

Question 18

Which internal revenue section allows for capital gains treatment of a family business stock redemption when it covers federal and state death taxes, funeral and administrative expenses; if the stock interest will be more than 35% of the stockholders adjusted gross estate

Answer 18

Internal revenue code, Section 303.
IRC 303 is helpful for liquidity at death to pay taxes. Redemptions must be made no later than three years and 90 days from due date of IRS Estate Tax form 706 or 60 days after court decision of contested .

Question 19

In this type of buy sell agreement, the partners obtain life insurance on each others lives, paying the premiums individually and are both the owner and beneficiary of the contract.

Answer 19

Cross purchase agreement

Question 20

What are the four attributes of a cross purchase agreement strategy?

Answer 20

Prevents exposures to the claims of entity predators

Provides for a potential step up in outside basis

May be between business owners and not the business entity itself

Maybe cumbersome to coordinate funding between many shareholders

Question 21

The IRS is very likely to reject a buy sell agreement based on what?

Answer 21

Book value

Question 22

_______ is typically a significant component of a business’s value and is often estimated by capitalizing future expected cash flow, earnings or EBITDA.

Answer 22

Terminal value

Question 23

Assets and transactions not typically eligible for installment sales tax treatment are

Answer 23

-Sells that result in losses.
-Depreciated property
-Gains from sale of the inventory used in trade or business
-Sale of a publicly traded stock.

Question 24

What are the six advantages of intrafamily installment sales?

Answer 24

The buyer receives a basis step up, equal to the purchase price

Any income generated by the asset is tax to the buyer, who is typically in a lower tax bracket

Only the value of the outstanding installment payments is included in the sellers estate. No, subsequent asset appreciation is included this results of the freeze in value.

The asset is retain within the family

The responsibility for maintaining the property and future appreciation is shifted to younger family members

The gain on an installment sale is deferred and tax ratably as payments are received.

Question 25

How do you calculate capitalize earnings?

Answer 25

Valuation= earnings / discount rate minus growth rate

Question 26

In a partnership liquidation, whether or not the partners recognize taxable gain or loss, depends on?

Answer 26

• The partners tax basis in their partnership interest
• The character of assets owned by the partnership

-The tax basis of the assets owned by the partnership.

The partnership itself recognizes no taxable gain or loss from the distribution of property in liquidation.

Question 27

What are the types of closely how business valuation discounts?

Answer 27

Buy sell restrictions
Stock not register for Public sale
Stock subject to SEC restrictions
Minority interest
Lack of marketability
Large block stock
Liquidation expense
Lack of operating diversification
Lack of investment diversification
Loss of key management person
Reoccurring investment losses
Built in capital gains
Corporate business problems
Lack of voting rights

Question 28

Section 1244 stock

Answer 28

To qualify a stock must be issued by a small businesses corporation.

Stock is worth less than $1mm

A loss of up to $100k MFJ maybe taken. Additional losses are ordinary capital losses

Question 29

Types of buy-sell agreements

Answer 29

1. Cross purchase agreement
2. Redemption
3. Entity purchase
4. Business buy-sell
5. Hybrid AKA Wait and see plan- entity + cross purchase approach.

Question 30

Are buysell agreements included in the insureds estate?

Answer 30

No. There are no incidents of ownership attributable to an insured business owner when the policies are owned by the business entity or co-owners.

If the insured possesses rights in the policy design to find a business purchase arrangement, then both the insurance proceeds, and the business interest may be included in the gross state.

Question 31

When are buy-sell insurance proceeds included in the insureds estate.

Answer 31

If the insured possesses rights in the policy design to find a business purchase arrangement, then both the insurance proceeds, and the business interest may be included in the gross state.

Question 32

What are the disadvantages of a “redemption agreement” buy sell agreement?

Answer 32

The C corporation could be subject to AMT

The insurance proceeds, could be exposed to corporate creditors

Undesirable divot in treatment

A remedy is to switch to a cross purchase agreement. Where are the business owners on the policy and would receive a step up an outside basis.

Question 33

What is a redemption by buy-sell agreement?

Answer 33

It is an agreement between the business and its owners, in which insurance proceeds or other corporate funds are used to buy out the deceased, disabled or retire, owners interest.

Question 34

Split dollar insurance, endorsement vs collateral assignment.

Answer 34

Endorsement method - the employer owns the policy and transfers an interest to the employee by way of an endorsement.

Collateral Assignment- the employee owns the policy and using assignment transfers interest to the employer.

Question 35

Types of split dollar arrangements?

Answer 35

Equity- excess cash surrender value owned by employee

Classic- excess accrued to employer

Reverse split dollar- employee owns policy and cash surrender, death benefit goes to employer.