Advising Business Owners Instructor: Dwight Drake Problem 16 Parties Objectives Jason: - Be assured control of business – not accountable to siblings. - Begin sharing in value growth now - Stop building more growth for siblings – Mom and Dad OK, but ultimately should make its way to Jason. - Make sure siblings (both insiders and outsiders) know the deal. - Minimize taxes and disruption to business. Mom and Dad - Financially secure and free for rest of lives. - Keep business strong with Jason running show. - Continue oversight of business with some authority. - Keep harmony in the family. - Give each child an equal share of estate. - Minimize taxes and disruption to business.

Advising Business Owners Instructor: Dwight Drake Problem 16 Parties Objectives Inside children: Judy and Luke - Be assured of job security in business. - Ideally some business equity and say in management. - Equal share of parents’ estate. - Keep business strong. - Assure parents’ financial needs and wants satisfied. - Minimize taxes and disruption to business. Outside children: Roger and Julie - Equal share of parents’ estate. - Assure parents’ financial needs and wants satisfied. - Escape business tie-ins and risks when parents out of picture. - Minimize taxes.

Advising Business Owners Instructor: Dwight Drake Problem 16 The Numbers Rough Cut on Parent’s Net Estate Value: Business Value 14 mill Other Assets (x insurance 8 mill Total 22 mill Unified credit protection 4 mill Potential taxable estate 18 mill Estate tax exposure (45%) 8 mill (+/-) Net after tax: 14 mill Plus: Insurance (assume tax- protected) 2 mill Net potential to kids 16 mill One-fifth share 3.2 mill

Advising Business Owners Instructor: Dwight Drake Gift Transition Strategy C Corp Jason Mom & Dad Gift 3 mill stock now Gift 66k stock a year 21.5% moving up 78.5% Moving down

Advising Business Owners Instructor: Dwight Drake Gift Transition Strategy - Parent’s use 2 mill gift tax unified credits to give Jason his 3 mill share of estate now in stock. Use minority interest and lack of marketability discounts to get there. - Parents use annual exclusions (for Jason and spouse) to gift with discounts additional 66k stock each year (44k discount adjusted to 66k) - Parents make similar offsetting annual gifts to other children to tax protect insurance through ILIT and to transition other assets through one or more family LLCs. - Parent’s estate (living trusts, wills) designed to eliminate any further interest of Jason until others have received transfers (after-transfer tax) of same 3 mill value. Then Jason share 1/5 of excess. If there s cumulative shortfall, no adjustment from Jason because Jason took risk of stock.

Advising Business Owners Instructor: Dwight Drake Negatives of Gift Transition Strategy - Parents still control bulk of stock and growth in parents’ estate. - Unclear how David gets control of company or rest of stock. - David takes low transfer basis in gifted shares. - Ongoing risk of double tax on dividends to parents down the road.

Advising Business Owners Instructor: Dwight Drake Gift with Redemption Strategy C Corp Jason Mom & Dad Gift 3 mill stock now Gift 60k stock a year 100% outstanding stock Balance of stock Installment Note

Advising Business Owners Instructor: Dwight Drake Gift With Redemption Strategy Pluses: - Jason gets all stock now. - Note to parents reflect balance of stock value. Negatives: - Exchange treatment to parents only if qualify under 302(b)(3) as complete redemption with no family attribution. For this parents can only be creditors – nothing else. - Note payments funded with after-tax dollars. - All remaining payments on note at parents’ death income in respect of decedent. Full income tax burden to heirs. - Tremendous debt burden for company now. - Jason gets no basis step-up for all payments to parents.

Advising Business Owners Instructor: Dwight Drake Cross Purchase Strategy C Corp Jason Mom & Dad Sale of stock 100% outstanding stock Installment Note

Advising Business Owners Instructor: Dwight Drake Cross Purchase Pluses: - Jason gets all stock now. - Note to parents reflect balance of stock value. - No big gifting required now to spook other kids. - Parents can retain any role – no more creditor limitation. - Jason gets stepped-up basis on all stock. Negatives: - Note payments still funded with after-tax dollars from Jason. - All remaining payments on note at parents’ death still income-in-respect of decedent. Full income tax burden to heirs. - Tremendous debt burden now on Jason. May mess up personal affairs. - Jason interest deduction. Investment interest tough. - How does Jason get money out of corp to cover payments? Comp, dividend. S election may help this and interest deduction. Normal conversion.

Advising Business Owners Instructor: Dwight Drake S Election – New Corp Strategy Old Corp Now S Jason Mom & Dad New Corp Employment Stock Equivalency Service/Management Contract 100% Jason Owned Tax-free Distributions After income Pass-thru Stock gifts over time Planned post-mortem buy-out ILIT On Parents Cash Transfers Death Benefit

Advising Business Owners Instructor: Dwight Drake S Election – New Business Strategy Pluses: - Parents have income for life. - No double tax or payroll issues to parents if sufficient current income - Jason’s control rights protected by contract. - New corp growth all Jason. - Full basis step-up in parent’s stock. First death planning option. - Future estate growth controlled with gifting program, contract rights and impact of new corp value - Parents insulated from growth risk of new corp. Negatives: - Operating base and assets of old may be needed for new. - Estate growth may occur for parents. - S Corp reasonable comp rules of 1366(e). Should be no problem. - Normal S Corp conversion issues.

Advising Business Owners Instructor: Dwight Drake Other Complimentary Strategies - Split off of separate company to under 355 Jason after he has been gifted stock and has become an historic shareholder. - Real estate rented to company put in LLC and used as gifting tool for other children. - Sales agreements between Jason and parent (either now or triggered at death) protect employee rights of inside children. - Insurance funded trade-off with other children: equalizing ILIT policy. May couple with attempt to shift values by restructuring capital of company. - Voting and non-voting common shares from S Corp conversion. Non-voting can pass to other child at death subject to buy-sell when Jason can swing purchase. Until then, distribution program continue. - Tax-free recapitalization at death of parents: common stock to Jason, preferred to others.