THE RETAINED EARNINGS TRIFECTA The One For Three Solution Thank you for taking the time today to talk with me about The One for Three Solution

C Corporation Owners Share Similar Concerns Managing Increases in Retained Earnings Avoid Unnecessary Tax Costs Provide the Business with Protection Against the Loss of a Key Person Retirement Income Personal Life Insurance Protection This is a situation involving successful business owners of a C Corporation. In addition to many concerns that you may have that are particular to your business there are some concerns that cross business lines.

Retained Earnings Loss of Key Person Future Personal Needs Three Key Issues Retained Earnings Loss of Key Person Of these, I’d like to spend a little time with you talking about excess retained earnings, dividends and the loss of a key person (whether that’s you, one of the other owners or a non owner key person). Future Personal Needs

Consider the Three Key Issues Retained Earnings Let’s start with retained earnings.

Retained Earnings Net Earnings or Increases in Asset Value What are Retained Earnings? It is a percentage of your net earnings not paid out as a dividend but retained by the company to be reinvested in its core business or to pay debts. In addition retained earnings may increase or decrease due to changes in asset value on the balance sheet. Basically, the operating results from a company's fiscal year is recorded to retained earnings, resulting in a increase or decrease to the account. If you think of your balance sheet, retained earnings are recorded under shareholders’ equity on your balance sheet. Net Earnings or Increases in Asset Value

Excess Retained Earnings? C Corporation Professional C Corporation Must be reasonable business need Must be reasonable business need Amount in Excess of $250,000 Amount in Excess of $150,000 A C corporation has a $250,000 retained earnings limit and a professional C Corporation has $150,000. These limits may be exceeded when the accumulation is for a reasonable business purpose. There are a number of ways to justify excess retained earnings and what would work for your business depends on many factors. Amounts in “Excess” of this may be subject to the Accumulated Earnings Tax. $250,000 Retained Earnings No business purpose need be stated $150,000 Retained Earnings No business purpose need be stated

Accumulated Earnings Tax 20% Penalty Tax The key here is that amounts in “Excess” of this may be subject to the Accumulated Earnings Tax. This is a tax imposed by the IRS, a penalty against your Excess Retained Earnings if it is perceived that the company is either trying to avoid or defer shareholder income tax through unnecessary accumulation of earnings. The AET is currently 20% (15% in 2012, 2011, 2010) This does not impact S Corporations, Partnerships or LLCs taxed as a Partnership. For additional information on accumulated earnings, select here.

Questions About the Accumulation Was the Accumulation Necessary? Was the Purpose To Avoid Paying Tax? ? The IRS will ask some key questions when determining if an Accumulated Earnings Tax should be charged or not. Was there a purpose to avoid paying tax? Was the accumulation necessary? Was it documented with your minutes? Was the Reason for the Accumulation Documented and Was the Program Implemented?

Business “Reasonable Need” Accrued income tax for the year 1 Working capital needs 2 Business expansion 3 Asset purchases 4 Statutory stock redemption 5 Major litigation (ongoing or anticipated) 6 Regulations and case law provide that an accumulation is reasonable if the corporation has specific, definite, and feasible plans for the use of the accumulation. Here are some reasonable needs as set in regulation and case law. Long term debt retirement 7 Specifically identifiable business contingencies 8

“Unlock” Excess Retained Earnings Key Person Buy Sell Business Debt Repayment Executive Benefit Arrangements ESOP Repurchase Liability Split Dollar Life insurance on the life of a business owner or a key employee solves a business need and is considered a legitimate business expense to offset retained earnings. The death benefit and potential cash value in a permanent life insurance policy owned by a business is a vital financial tool that may help your business in several areas. Here are just a few situations where life insurance used to solve the need may aid with the retained earnings problem. [When presenting if you would like a brief explanation of any of the business uses of life insurance please click on the specific solution you would like to discuss and more detail will be provided.] For additional information on a subject, single click on the selection To continue the presentation select here.

Key Person Life Insurance Protect the Business From Losses Due to the Death, Disability or Retirement of a Key Person Key person life insurance is purchased to protect the life of a key person. It is owned by and payable to the business. The income tax-free death benefit can be used to replace potential lost income and/or to cover the costs of replacing the key person. Return to Main Page

Buy-Sell Funding Preparing the Business to Fund a Business Succession Plan Buy-Sell life insurance is a common financial tool used in a buy-sell arrangement to establish the terms of a business succession strategy upon the death, disability, or retirement of an owner. Return to Main Page

Business Debt Repayment Establishing a Fund to Repay Debt to Third Parties Business Debt Repayment life insurance can be used to secure repayment of loans in the event you or a key person dies before the loan is repaid. Eliminating or paying down debt may assure the ongoing success of your business. Return to Main Page

Employee Stock Option Plan Preparing the Business to Fund Repurchase Liability under an ESOP If you have an Employee Stock Option Plan you will generally have a repurchase obligation on shares of the business that have been distributed from the ESOP. Life insurance can help defray the cost of that liability. Return to Main Page

Split Dollar An Executive Benefit Arrangement That Allows the Business and Key Person to Share the Benefits and Costs of a Permanent Life Policy Split Dollar arrangements are a key method of providing special benefits to your key executives. The Economic Benefit Arrangement provides both key person and death benefit only coverage. A Split Dollar Loan provides permanent life benefits to the executive at a reduced personal out of pocket cost, while providing the business with cost recovery. Return to Main Page

Non-Qualified Executive Benefits Special Benefit Arrangements That May Provide Retirement and Death Benefit Protection to Select Employees of the Business The death benefit or policy cash values of business owned life insurance may be used to help pay for Non-Qualified Executive Benefits such as Deferred Compensation Plans or Salary Continuation. Return to Main Page

Reasonable Business Needs Statutory Buy Sell Key Person Business Debt Repayment Executive Benefit Arrangements There are a number of ways to establish a reasonable business need for accumulating earnings. These include statutory buy sell funding, repayment of business debt, establishing a split dollar arrangements, funding an ESOP repurchase liability, informally funding an executive benefit arrangement and, very importantly – protecting against the loss of a key person. The use of life insurance to help formally or informally fund programs is an important component in the one for three solution. We will look at this in more detail. Split Dollar ESOP Repurchase Liability

Consider the Three Key Issues Dividends Let’s think about dividends.

Dividend Distribution Distributions made to shareholders that are not in the nature of compensation will be treated as a dividend. Dividend payments are not tax deductible to the business and are subject to the dividend tax rate in effect at the time the dividend is received. This distribution has effectively been taxed twice, once at the corporate level and once at the personal level. This is not necessarily a bad thing – but this tax result must be considered when distributions are made. Distribution Paid Out As A Dividend

Dividend Distribution Distributions to the shareholder may be treated as a dividend. If so, then this money has been subject to double taxation: once to the profits in the business and then again at the business taxed rate. The second tax is the dividend tax the shareholder will pay upon receipt of the funds. Because a dividend payment is non deductible, the funds have been taxed twice. Double Taxation

Consider the Three Key Issues Key Person Last, let’s look at the loss of a key person.

You Know Who Your Key People Are The Secret Sauce Imagination The Deal Hard Work

Key Person Loss Loss of Market Confidence  Key Skill Set Lost  Replacement Costs  Clients Could Go to Competitor  Staff Defections  Here are some of the potential issues that can arise if a key person dies, becomes disabled or simply leaves work. Business Debt / Bonding  Suppliers Could Require Different Payments  Profits Could be Reduced 

Valuing a Key Person Different Methods Available Multiple of Salary Multiple of Profits Different Methods Available Actual Impact Proportion of Payroll

Considering the Three Key Issues Future Personal Needs

Future Personal Needs Death Benefit Protection  Potential Retirement Accumulations  Living Benefits  The ability of a life insurance contract to accumulate sufficient cash value to provide retirement income will be dependent upon the amount of extra premium paid into the policy, and the performance of the policy, and is not guaranteed. Policy loans and withdrawals reduce the policy’s cash value and death benefit and may result in a taxable event. If remaining policy values and scheduled premiums are insufficient, additional out-of-pocket payments may be needed to keep the policy inforce. Surrender charges may reduce the policy's cash value in early years. Living Benefits are provided by no additional premium Accelerated Benefit Riders. Payment of Accelerated Benefits will reduce the Cash Value and Death Benefit otherwise payable under the policy. Receipt of Accelerated Benefits may be a taxable event and may affect your eligibility for public assistance programs. Please consult your personal tax advisor to determine the tax status of any benefits paid under this rider and with social service agencies concerning how receipt of such a payment will affect you. Riders are supplemental benefits that can be added to a life insurance policy and are not suitable unless you also have a need for life insurance. Riders are optional, may require additional premium and may not be available in all states or on all products. This is not a solicitation of any specific insurance policy. The ability of a life insurance contract to accumulate sufficient cash value to provide retirement income will be dependent upon the amount of extra premium paid into the policy, and the performance of the policy, and is not guaranteed. Policy loans and withdrawals reduce the policy’s cash value and death benefit and may result in a taxable event. If remaining policy values and scheduled premiums are insufficient, additional out-of-pocket payments may be needed to keep the policy inforce. Surrender charges may reduce the policy's cash value in early years. Living Benefits are provided by no additional premium Accelerated Benefit Riders. Payment of Accelerated Benefits will reduce the Cash Value and Death Benefit otherwise payable under the policy. Receipt of Accelerated Benefits may be a taxable event and may affect your eligibility for public assistance programs. Please consult your personal tax advisor to determine the tax status of any benefits paid under this rider and with social service agencies concerning how receipt of such a payment will affect you. Riders are supplemental benefits that can be added to a life insurance policy and are not suitable unless you also have a need for life insurance. Riders are optional, may require additional premium and may not be available in all states or on all products. This is not a solicitation of any specific insurance policy.

The Retained Earnings Trifecta Specially Designed Business Owned Life Insurance If any of these issues concern you – you may want to considered adopting the one for three solution. This starts with the business acquiring a specially designed business owned life insurance policy on your life and/or the life of the other key people.

The One For Three Solution Key Person Retained Earnings And Dividends Future Personal Needs 28

How it Works Business purchases life insurance Fund identifiable need Cash account is reduced. Cash value is an asset. Policy transferred once business no longer needs the policy Transferred to insured-employee Fair market value included as income or a dividend Let’s review how the One for Three solution works….(read slide) The new policy owner owns all rights and benefits of the policy Right to exercise riders (if any); use of cash value (if any) Additional premium payments may or may not be needed

1 – Reduce Retained Earnings and Dividends How does this help? Let’s start with the retained earnings. The impact on the balance sheet is fairly straightforward – Your cash account will be reduced when the premium is paid. The cash value of the policy will be reflected on the balance sheet as an asset. To the extent the cash value is lower than the premium paid, the net effect will be to lower the retained earnings in the business.

2 – Key Person Income Tax Free Death Benefit  Provides Financial Cushion  Replacement and Recruiting Costs  Next, the life insurance will act as a financial back stop against the loss of a key person. By delivering the death benefit to the business at the death of a key person, the business will have the funds to help it survive the financial challenges that it now faces.

Two – Business Owned Insurance Protects Against Loss of Key Person Let’s take a look at what the key person protection looks like.

Two – Business Owned Insurance Protects Against Loss of Key Person – At Death Income Tax Free Death Benefit* Increase in Retained Earnings With Reason for the Accumulation At death, the business will receive the death benefit, increasing the cash account. The death benefit will be delivered on an income tax free basis, assuming the requirements of IRC Section 101(j) were met. That means a notice and consent form must have been completed by the business and the insured prior to the policy being issued. The retained earnings will increase by the death benefit (in excess of the cash value) received by the business. The key to this accumulation is to have noted the reason for the accumulation – most particularly to created a financial cushion at the loss of the key person. * Must have complied with the requirements of IRC Section 101(j)

Three – When Business Needs Change Transfer the Policy to the Insured Income or Dividend Personally Enjoy the Benefits of the Policy Third, when the business needs change and it no longer needs or wants the policy, the business may decide to distribute the policy to the insured. This distribution to a shareholder will likely be treated as a dividend. But here’s an important point– to the extent the fair market value is lower than the total premium paid, the policy has been distributed effectively at a discount. You then have a permanent life policy – which may or may not require additional premiums.

Transfer Policy to the Insured When the business no longer needs the policy, the business may, but does not have to, transfer the policy to the insured. You will include the value of the policy as income or a dividend – you should consult with your CPA as to how they would characterize the distribution. Include Fair Market Value as Income or Dividend

Retained Earnings Reduced The effect of transferring the policy off the business’ books is to reduce the retained earnings by fair market value of the policy transferred.

Personally Owned Permanent Policy The result to you as the insured is to now own a permanent life insurance policy and you will be able to enjoy all the rights and benefits of the policy.

Is This Concept Right for You? C Corporation with excess retained earnings 1 Business need for life insurance such as key person protection 2 Desire to reduce exposure to Accumulated Earnings Tax 3 Potential future personal desire for benefits of permanent life insurance 4 The ideal candidate for the Retained Earnings Planning Concept is: A C Corporation with excess retained earnings A business that requires life insurance coverage on the owner or key executive A business that would like to reduce the need to declare dividends and prevent exposure to the Accumulated Earnings Tax

Results Business has life insurance coverage on key person Possible reduction of Retained Earnings Possible reduced exposure to Accumulated Earnings Tax Many positive results are the result of including life insurance in your planning: The business has insured the life of an owner or key person It allows possible reductions of further accumulations to retained earning and reduced exposure to the Accumulated Earning Tax. You can transfer or sell the policy to the insured at a future date; The policy can potentially be used for estate planning; And the policy can potentially be used for retirement income if there is sufficient cash value, through the use of policy loans and withdrawals.. Repurpose insurance to personally owned

Next Steps Understand your current business situation, goals and objectives 1 Analyze information 2 Review options and opportunities 3 Implement an appropriate strategy 4

IRS Circular 230 Disclosure IRS CIRCULAR 230 REQUIRES US TO INFORM YOU THAT THE ABOVE INFORMATION IS NOT INTENDED OR WRITTEN TO BE USED, AND IT CANNOT BE USED, BY ANY PERSON FOR THE PURPOSES OF AVOIDING ANY PENALTY THAT MAY BE IMPOSED BY THE INTERNAL REVENUE SERVICE. In the event the advice is also considered to be a “marketed opinion” within the meaning of the IRS guidance, then as required by the IRS, please be further advised of the following: THE ABOVE ADVICE WAS WRITTEN TO SUPPORT THE PROMOTION OR MARKETING OF THE TRANSACTIONS OR MATTERS ADDRESSED BY THE WRITTEN ADVICE AND, BASED ON THE PARTICULAR CIRCUMSTANCES, YOU SHOULD SEEK ADVICE FROM AN INDEPENDENT TAX ADVISOR.