Ex­pert ad­vice is key when sell­ing busi­ness

The Denver Post - - BUSINESS - By Gary Miller

Home from a long cruise, Bob and Marge stopped by the post of­fice to pick up their mail. One let­ter stood out — a no­tice from the IRS stat­ing that it had dis­al­lowed a tax de­duc­tion of $547,400 from the cou­ple’s 2015 per­sonal tax re­turn. In ad­di­tion to ow­ing back taxes on the dis­al­lowed amount, they also owed penal­ties and in­ter­est. An IRS au­dit that be­gan eight months ear­lier ex­am­in­ing the sale of their busi­ness had led to this dev­as­tat­ing news. How could this hap­pen? In the fall of 2015, Bob had sold his busi­ness for $23 mil­lion in a cash and stock sale to a pub­licly traded com­pany. Dur­ing the trans­ac­tion process, Bob re­ceived a bind­ing Let­ter of In­tent (LOI) from the pur­chaser. Af­ter ne­go­ti­at­ing some of the fine points of the terms and con­di­tions, Bob signed the LOI. Fol­lowed by the suc­cess­ful due dili­gence re­view, the sale closed.

Once Bob had signed the LOI, he and Marge be­gan se­ri­ously think­ing about what they were go­ing to do with the money from the sale. Bob called his ac­coun­tant and his fam­ily prac­tice at­tor­ney, who had ad­vised him for years, to dis­cuss their op­tions. Bob and Marge did not have a fi­nan­cial ad­viser as Bob al­ways had man­aged their investment port­fo­lio him­self.

Bob’s at­tor­ney ad­vised him to es­tab­lish a Char­i­ta­ble Re­main­der Trust (CRT). Mak­ing a do­na­tion to the CRT could help re­duce in­come taxes and es­tate taxes, avoid cap­i­tal gains taxes on the do­na­tion and re­ceive in­come from the trust for the next 20 years. They were thrilled and de­cided to do­nate 10 per­cent of the $23 mil­lion from the sale to their alma mater. Bob do­nated 230,000 shares of stock to the trust with a cost ba­sis of $1 per share or $230,000. The pub­licly traded com­pany’s shares were val­ued at $10 per share or $2.3 mil­lion. There­fore, Bob would re­duce his tax­able es­tate by $2.07 mil­lion ($2.3 mil­lion – $230,000 = $2.07 mil­lion). Also, Bob avoided pay­ing the cap­i­tal gains tax of 23.8 per­cent on the ap­pre­ci­a­tion of the do­nated stock. Bob and Marge elected to re­ceive 7 per­cent of the earn­ings from the $2.3 mil­lion trust generating about $161,000 of tax­able in­come per year for the next 20 years — a win-win for all.

But the IRS dis­al­lowed most of the tax sav­ings from the CRT, be­cause Bob had not started his fi­nan­cial plan­ning soon enough. He es­tab­lished the CRT af­ter he had re­ceived the LOI from the pur­chaser in­stead of es­tab­lish­ing his es­tate plan well in ad­vance of the sale of his com­pany. The IRS held that the CRT had vi­o­lated the An­tic­i­pa­tory As­sign­ment of In­come Doc­trine which was ad­ju­di­cated in 1930 by the Supreme Court to limit tax eva­sion. By es­tab­lish­ing the CRT af­ter he had signed a bind­ing LOI gave the ap­pear­ance to the IRS that the CRT was noth­ing more than a scheme to evade taxes.

What should Bob and Marge have done to pre­vent the IRS prob­lem?

First, Bob should have started his busi­ness exit plan­ning in­clud­ing es­tate plan­ning as early as pos­si­ble be­fore the sale of his com­pany. Many wealth plan­ning ex­perts rec­om­mend that plan­ning should be­gin from one to five years be­fore the sale of the com­pany

Sec­ond, had Bob hired a Reg­is­tered Investment Ad­viser early in the exit plan­ning process, the ad­viser would have ex­am­ined Bob and Marge’s en­tire fi­nan­cial pic­ture, as­sess­ing Bob’s and Marge’s goals. That would have been the time to es­tab­lish the CRT and a Donor Ad­vised Fund (a char­i­ta­ble giv­ing ve­hi­cle spon­sored by a pub­lic char­ity that al­lows the donor to make a con­tri­bu­tion to that char­ity and be el­i­gi­ble for an im­me­di­ate tax de­duc­tion) to re­duce in­come taxes and to achieve Bob’s and Marge’s goal of sup­port­ing their alma mater.

“Bob should have started his plan­ning at least six months in ad­vance of re­ceiv­ing the LOI. Any­thing less could spell trou­ble with the IRS,” said Shel­ley Ford, a fi­nan­cial ad­viser with Mor­gan Stan­ley Wealth Man­age­ment.

She con­tin­ued, “Bob should have en­gaged key ad­vis­ers in­clud­ing an exit-plan­ning M&A con­sul­tant, a trust and es­tate plan­ning at­tor­ney, a trans­ac­tion at­tor­ney to guide the ne­go­ti­a­tions of the trans­ac­tion and cor­po­rate and per­sonal tax ad­vis­ers to give ex­pert ad­vice on how and when to es­tab­lish their es­tate plans in an­tic­i­pa­tion of Bob sell­ing his com­pany.”

Scott Flem­ing, re­gional pres­i­dent – Rocky Moun­tain re­gion for BNY Mel­lon Wealth Man­age­ment, agreed.

“Wealth plan­ning should be­gin as early as pos­si­ble, with a team of ex­perts to ex­am­ine all of the avail­able in­come and es­tate tax sav­ings strate­gies, to avoid what hap­pened to Bob and Marge,” Flem­ing said. “Had they started their plan­ning early enough, they could have ex­am­ined a num­ber of in­come and es­tate plan­ning strate­gies in or­der to meet their per­sonal goals and at the same time avoid/de­fer in­come and es­tate taxes.”

Flem­ing con­tin­ued, “Strate­gies of­ten ex­am­ined are a Gran­tor Re­tained An­nu­ity Trust, a Gran­tor Re­tained In­ter­est Trust, a Gran­tor Re­tained Unit Trust, an In­ten­tion­ally De­fec­tive Gran­tor Trust, Ir­rev­o­ca­ble Life In­sur­ance Trust, Char­i­ta­ble Lead Trust and po­ten­tially a Fam­ily Lim­ited Part­ner­ship.”

Un­for­tu­nately, Bob made a num­ber of mis­takes that could have been avoided had he sought spe­cific pro­fes­sional ad­vice. And while his at­tor­ney and ac­coun­tant tried to give good ad­vice, they were not ex­perts in es­tate plan­ning and wealth preser­va­tion. Bob and Marge paid the price for not hir­ing ex­perts.

Gary Miller is the CEO of GEM Strat­egy Man­age­ment, Inc., an M&A con­sult­ing firm, ad­vis­ing mid­dle­mar­ket pri­vate busi­ness own­ers pre­pare to raise cap­i­tal, sell their busi­nesses or buy com­pa­nies. He is a soughtafter busi­ness con­sul­tant and speaker on M&A is­sues, strate­gic busi­ness plan­ning, busi­ness val­u­a­tions, exit plan­ning, what buy­ers are look­ing for in ac­qui­si­tions and how to pre­pare for due dili­gence. He can be reached at 970-390-4441 or gmiller@gem­strat­e­gy­man­age­ment.com

J. David Ake, The As­so­ci­ated Press file

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