Success in Exiting

Planning for succession or sale Estate Planning and Personal Wealth Issues Peering into the crystal ball of income tax law and estate tax law changes Presented by: Bob Nemeth, Apple Growth Partners Arthur Gibbs, Hahn Loeser + Parks LLP

Introduction

Business Succession Planning Strategic planning for the future of both the business and the owner Plan for the transfer of ownership, and ongoing management and control of a business

Benefits of Succession Planning Achieve business and personal goals Facilitate your retirement Control how and when you exit

Benefits of Succession Planning Ensure survival and growth of the business Preserve family harmony Reduce employee and family uncertainty

Benefits of Succession Planning Maximize company value Minimize, defer or eliminate capital gains, estate and income taxes Have strategic options to choose from

What’s it Worth?

What are You Valuing? Company as a whole (TIC or Equity) Value of a controlling interest in stock Value of a minority interest in stock

Strategic Value Strategic Premium Control Value Control Premium Minority Discount Marketable Minority Interest Value Discount for lack of marketability Non-marketable Minority Interest

Valuation Approaches Asset Approach Income Approach  Discounted Cash Flow  Capitalization of Earnings – a single period model Market Approach  Guideline Company Method – Public  Private Transaction Method

Overview of the Federal Estate Tax and Federal Gift Tax Where we were, where we are now and where we are heading

Federal Estate and Gift Tax Prior to the Year 2001 (Need to know where we were before we can figure out where we are headed) Under Pre-2001 tax law changes, the applicable exclusion amount for the estate tax (the amount each person can pass tax free at death) was scheduled to be $1,000,000 by the year The applicable exclusion amount for gift tax (the amount you can gift tax free) was scheduled to be $1,000,000 by the year Note: If a person used all of his/her gift tax exclusion amount during lifetime, such person would not have any estate tax exclusion amount to apply to his/her estate at death. 55% tax (in some cases, 60% tax) Annual Exclusion Gifts - $10,000 indexed for inflation Step-up in basis at death

Why are the Pre-2001 tax laws important? Because if Congress does not act, these laws will become the law again in 2011.

Federal Estate and Gift Tax From 2001 to 2009 (Need to know where we were to figure out where we are headed) Economic Growth and Tax Relief Reconciliation Act of 2001 (affectionately referred to as “EGTRRA” or the “2001 Tax Act”) Increased the Gift and Estate Applicable Exclusion Amounts and lower Tax Rate Law went into effect in 2001 EGTRRA contained a “Sunset Provision”  Generally, there was some concern that EGTRRA could not get the 60 votes in the Senate needed to make it permanent  Under the Byrd Rule, named after Senator Byrd of West Virginia, a tax relief law may be passed with less than 60 votes, provided law is not in effect for more than 10 years

YearEstate Tax Exemption Amount Estate tax Rate Gift Tax Rate Gift Tax Exemption Amount 2008$2,000,00045% $1,000, $3,500,00045% $1,000, No Estate TaxN/A35%$1,000, $1,000,00055% $1,000,000

2010 Estate and Gift Tax Laws Gift Tax  35% top rate rather than 45% Key: Gift Giving  $1,000,000 lifetime applicable exclusion amount  $13,000 annual gift tax exclusion Estate Tax  No Estate Tax if person dies in 2010 Note: Unless new law is enacted No Step-Up in Basis Carry Over Basis  $1.3m increase in basis as allocated by Executor  Extra $3m increase in basis for assets passing to a surviving spouse.

Possible Changes to the Estate and Gift Tax in 2010 Legislation during 2010  Permanently Extend law of 2009?  $5m exemption and 35% rate?  Permanent repeal?  Pre-2001 Laws? Legislation Retroactive back to January 1, 2010?  It is possible. Crystal Ball: $3.5m to $5m estate exemption with rate between 35%-45% Applied retroactively

What to do with Existing Estate Planning Documents For couples with combined assets in excess of $1m, have Wills and Trusts reviewed by counsel. Amend documents to address death in 2010 if law not changed.

Business Succession Planning Why Plan Now? Minimize Estate and Gift Taxes by transferring ownership to next generation over time instead of at death. Minimize risk that business succession goals of current generation will not be met. Maximize Options  Longer current generation waits, the fewer the options for a successful sale or transition to next generation. Evaluate ability of next generation to run the business and determine whether “outsider” will be needed to run business. Start involving next generation in management decisions to prepare them for successfully running business.

Technique #1 – Annual Exclusion Gifts Recapitalize company with voting and non-voting interests. Non-voting interest may receive a valuation discount. Gift up to $13,000 (or $26,000 if gift-splitting with spouse) each year to each child. If child young or not actively involved in business, consider gifting to an Irrevocable Gifting Trust.

Technique #2 – Utilize all of a portion of Gift Tax Applicable Exclusion Amount Up to $1,000,000 (or $2,000,000 if spouse joins in gift). Gift non-voting interests to child or Irrevocable Gifting Trust.

Technique #3 – Grantor Retained Annuity Trust (“GRAT”) Transfer interest in Company to irrevocable trust. Transferor receives a fixed annuity payment for a set number of years. Can minimize amount of gift tax based on annuity payment. At the end of the chosen term of years, annuity payments end and property remaining in the GRAT is either transferred to children or remains in Trust for children’s benefit.  Purpose: Appreciation is transferred to next generation virtually free of all estate and gift tax. Works well for a company expected to appreciate over time. Currently, two year GRAT allowed; new laws may be enacted to require a 10-year GRAT term.

Technique #4 – Sale to Defective Grantor Trust Owner creates a trust and makes a modest gift of cash to the Trust. Owner sells part or all of his business interest (preferably non-voting interests) to a trust in return for a down payment and an installment promissory note for the balance of purchase price. Trust designed so that the sale not subject to income tax and payments on the promissory note also will not be subject to tax. Additionally, the trust’s share of income generated by business will be taxed to the person who created the trust, further reducing the person’s assets and subject to estate tax upon death. Unpaid balance of promissory note, not the business interest transferred to the Trust, will be subject to estate tax upon the person’s death. Works well when business is expected to appreciate in value, the business owner desires to transfer business to next generation, and business generates cash flow.

Gift to a Stand Alone QTIP Trust Only for Gift property in 2010 to QTIP Trust. If gift tax rate is 35% in 2010, and increase to 55% in 2011, do not elect QTIP treatment so a gift results. If gift tax rate is 45% or 55% in 2010, and person does not want to trigger gift tax, make a partial or full QTIP election so all or a portion of the property qualifies for marital deduction. Key: Decision whether to make QTIP Election does not have to be made until 2011, when the 2010 income tax return is due.

Now that you have let the next generation in, what do you do to keep them from exercising too much control? Close Corporation Agreements  Do away with Board of Directors  Do away with annual meetings  Allow one person to manage the day-to-day affairs Buy Sell Agreement  Restrict sales and transfers to third parties  Prohibit transfers to your children’s spouse (especially in light of divorce)  Provide a mechanism to purchase in the event of death or bankruptcy

Soft Issues All families are dysfunctional Honestly evaluate the next generation and their ability to run and grow the business Involve next generation in management issues as early as possible Discuss your succession plans openly with the next generation Consider an outside consultant to evaluate family dynamics and provide recommendations as to the future of the business

Income Tax - What’s New? Making Work Pay Credit American Opportunity Tax Credit First-Time Home Buyer Credit Roth IRA Conversion

Income Tax - What’s New? Section 179 deduction Bonus depreciation NOL carryback

Income Tax – What’s Next

Income Tax - What’s Next? Potential increase in the individual marginal rates of 33% and 35% to 36% and 39.6% Potential increase in the long-term capital gains tax rate of 15% to 20% Potential itemized deduction cap at 28% in taxes Increase state and local enforcement

Robert M. Nemeth, CPA/ABV, CVA, CDFA, CFE Apple Growth Partners 6690 Beta Drive, Suite 210 Mayfield Village, OH Phone: (440) Arthur E. Gibbs III Hahn Loeser + Parks LLP 200 Public Square, Suite 2800 Cleveland, OH Direct Dial: (216) IRS CIRCULAR 230 DISCLOSURE In compliance with requirements imposed by the Internal Revenue Service, we inform you that any Federal tax advice contained in this communication (including any attachments) is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding any penalties under the Internal Revenue Code, or (ii) promoting, marketing or recommending to another party any transaction or matter addressed herein.