ELITE ADVISOR BEST PRACTICES

What CPAs and Attorneys Can’t Do for Clients

And what they often don’t do

By Richard L. Harris

Key Takeaways:

  • The CPA and attorney provide strategies and documents to deal with and reduce estate and business continuation issues.
  • They can’t create the dollars to solve the problems.
  • They often don’t model the results of their work, leaving the client with a false sense of security.


When an attorney or CPA has a client with a substantial estate or business interest, the professional recommends planning to determine the risks and prescribe strategies that will reduce the consequences of anticipated problems. Repeat: The strategies, if successful, reduce the cost of the problem, but they don’t eliminate it. And with each problem described in dollars, there are emotional issues attached. Other emotional issues such as estate equalization or providing for children from a former marriage may or may not be addressed.

For the large estate, attorneys and CPAs tend to recommend strategies to freeze values at current levels, discount the values to reduce taxes, and arbitrage government-prescribed interest rates against the potential return of assets. These strategies include:

  • Grantor-Retained Annuity Trusts (GRATs)
  • Sale to Intentionally Defective Grantor Trust (IDGT)
  • Charitable Remainder Trusts (CRTs)
  • Charitable Lead Trusts (CLTs)
  • Outright loans to family members

In the case of business owners, attorneys and CPAs will additionally recommend business continuation plans. However, when all is said and done, these professionals cannot provide the dollars to solve the problems.

Where common business continuation plans fall short

Let’s look at common business continuation plans—the buy-sell or stock redemption arrangement. There should be four elements that are dealt with in those plans:

  1. The retirement of one of the owners
  2. An owner wishing to be bought out
  3. The death of one of the owners
  4. The disability of one of the owners

What the professionals do is come up with a plan and draft documents that set a way to value the business, define disability and describe how payments will be made to the retiring, selling or disabled owner or the deceased owner’s estate. What they don’t often do is ask the business owners how they would manage making the payments in any of those eventualities. And they don’t look at the emotions and reactions of buyer and seller.

Real-world example

As an example, let’s look at a business valued at $20 million with two equal owners. They enter into a buy-sell agreement that states that the payments for any cause will be amortized over ten years, plus interest. Using Steve Leimberg’s NumberCruncher, assuming that the interest rate will be 2.60 percent (the minimum rate chargeable for a ten-year loan in May 2013), the interest is deductible, and the buyer is in a combined federal income tax and Medicare bracket of 43.4 percent, the buyer will have to earn $1,829,788 the first year to have enough left to make the $1,148,500 payment that is due. Bank financing would increase the number. The amount of before-tax earnings needed to make the payment increases each year as the principal is paid down and there is less deductible interest. What would the owners’ reactions be if they were told specifically what they are obligated for? Could they make the payments? What effect does making the payments have on the viability and growth of the business?

Enter insurance

Can the CPA or attorney provide the dollars to make the problem more palatable or make it go away entirely? With the buy-sell agreement partially or fully funded with life and disability buyout insurance, the picture changes dramatically. Either the payments are lowered to a more palatable amount or they are eliminated entirely. What is the cost of insurance to fund the $10 million agreement versus the $11,148,500 (approximately $19 million earned before taxes) the buying owner would have to pay? Which would the owners rather pay—the premiums or the installment payments?

The same type of analysis also holds true for estate planning techniques. After all the planning has been completed and implemented, what does the estate look like? Each planning technique, other than giving everything away to charity, will still leave assets in the estate. Determining the amount left in the estate is very important. The amount left is still subject to estate taxes and is therefore still a problem. Here are questions to ask to calculate what is left for the following two techniques:

1. GRAT
  • How much value comes back to the grantor as annuity payments?
  • What happens if the grantor dies before the GRAT is over?
  • What is the discount (if any) on the value of the asset being put into the GRAT?
2. Sale to an IDGT
  • Is the note a Self-Canceling Installment Note (SCIN)
  • What is the life expectancy of the seller?
  • What are the annual payments?
  • What are the terms of the note?
  • Is the principal paid in installments or paid at the end of the term?
  • What are the installments?
  • What is the discount (if any) on the value of the asset being sold?

In a CLT, the donor gives a charity an annuity or percentage of principal payable at least annually. The amount that is left at the end of the term goes as a gift to beneficiaries. If a CLT is used, how much is going into the trust? What is the value of the gift at the end of the term? The value of the gift is used as a reduction from the lifetime unified credit to calculate the tax of the donor’s estate. The Charitable Remainder Trust operates exactly opposite. The payments go to the donor and the remainder goes to the charity. If a CRT is used, what are the payments to the recipient?

A loan to a family member involves having the loan repaid plus interest. What is the principal of the loan? What interest rate is used? What is the term of the loan?

Conclusion

What the CPA and attorney do is identify a problem and propose a partial solution. Even if the strategies employed limit and/or reduce the costs, they don’t eliminate them. Only someone who can create the dollars to cover the eventualities can really solve the problems.

To end, here is a cautionary example of that kind of planning and the results:

I was referred to the owner of a very well-known and successful men’s clothing store. His father created the business. His father’s estate plan stated that when he died, the heirs would elect IRC Section 6166 to pay the taxes due on the business. This allowed for the payment of estate taxes due on the business to be made over 15 years. The first five years of payments would be just interest. The estate taxes on other assets would still have to be paid within nine months of the father’s death. The son wanted life insurance so that when he died, his heirs would not face the same problem as he did. Unfortunately, the business ultimately could not survive the weight of the liability to the government. And the remaining taxes still had to be paid.


About the Author

Richard L. Harris specializes in life insurance sales and consulting for high-net-worth individuals and their advisors. For more than four decades, he has been a trusted expert for accountants, attorneys and trust officers. A life insurance agent, he holds the professional designations of Chartered Life Underwriter, Registered Trust and Estates Practitioner, and Accredited Estate Planner. He may be reached at Richard@rlharrisllc.com or 973-470-5151.