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An Overlooked Source of Capital

Business Planning Opportunities

Most Business owners put their maximum efforts into creating and running their businesses. But additional planning must be done to insure that the business can survive the death, disability or retirement of an owner or key employee.

The unique issues related to succession planning, risk mitigation and family income planning present unique challenges and considerations that are related to the running of a business:

Some of those challenges and considerations include:

  • Is there access to liquidity to take advantage of growth opportunities, or to supplement business income in tough economic times?
  • Retention of key employees is integral to the success and growth of the business.
  • Continued income for family members in the event of premature death or disability of the business owner and/or their partners.
  • The transfer of business interests to a family member or trusted employee/partner to ensure that the business is a going concern and continues to provide income during retirement of the primary partner.
  • A formalization of the business owner’s wishes and intent to surviving partners and family members
  • The strategies and techniques available to small business owners for retirement planning.

Results of Failing to Plan

Running a business is challenging enough … and the time and monetary resources required to create succession plans seems like time off task. But the reality of failing to plan creates this:

  • Lack of liquidity to facilitate the purchase of business interests by surviving or remaining partners, leaving family members with an unmarketable interest in the business.
  • Confusion and disagreements as to deceased partner’s intent for successors and other family members involved in the business and their ongoing roles.
  • Loss of control of the business upon premature death of the owner.
  • Inability to retire comfortably when desired.
  • Loss of tax-advantageous transfer techniques that require advanced planning and structure…prior to the death of the owner.

Creating a Legacy

What do you want to happen regarding the future of your business?

  • While you’re still an active part of the business
  • When you decide to retire
  • If something happens to you (your death or disability)

Q. What would be the impact on your family of this business failing on your death or disability?

Q. What is your business worth? How do you arrive at that amount?

Q. What would happen to your business if Key Person or Key Persons were suddenly gone? Are you insured against that loss

Q. How would the current debt of the business be paid if you are not around?

Q. Is your current retirement plan up to date and is it performing the way you intended?

Q. Do you need additional tax deductions related to your business?

Q. Are you rewarding and motivating your employees so that the business is able to retain them long-term?

Q. How many family members are currently involved in the business? Will this change in the future?

Q. Loss Protection: what techniques are in place now, above and beyond the replacement of the physical property, inventory and location of the business?

Q. What estate planning have you done in regards to your personal or business assets?

Q. Have special provisions with specific regard to your business been made in your legacy planning?

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When Golden Handcuffs Makes Sense

What Is Nonqualified Deferred Compensation?

Nonqualified deferred compensation is an arrangement established by employers to provide retirement income and often death and/or disability benefits to selected managers or highly compensated employees. When it’s properly arranged, the employee can defer income taxation until the benefits are paid.

Deferred compensation arrangements are “nonqualified,” which means they don’t have to be preapproved by the IRS, and employers can favor selected employees without risking claims of discrimination. Also, when properly arranged, they are exempt from nearly all of ERISA’s regulatory requirements.

How Does It Work?

A nonqualified deferred compensation arrangement typically provides that an employee will receive a stipulated sum for a fixed period of time—or for life—beginning at a future date, such as the employee’s retirement. If an employee dies after payments have begun, the arrangement may direct that the remaining benefits be paid to the employee’s beneficiary.

The arrangement may provide that the employee will receive future compensation as a result of a current salary reduction or in lieu of a bonus or salary increase. This is sometimes called a “true deferral arrangement.”

An alternative is a “salary continuation arrangement.” Here, the employer commits to pay future compensation to the employee in addition to current earnings, which aren’t reduced by participation in the arrangement.

What’s the Tax Picture?

Generally speaking, the deferred amounts in an unfunded plan are includible in the employee’s gross income when they are actually or constructively received. The deferred amounts in a funded plan are currently includible in the employee’s gross income unless they are subject to a substantial risk of forfeiture.

The employee can lose income tax deferral if the arrangement doesn’t follow the rules of IRC §409A (for example, if an employee has control over deferred amounts or has early access to them).

Amounts deferred under a deferred compensation plan will be includible in the employee’s gross income for all tax years in which such amounts are not subject to a substantial risk of forfeiture if the plan fails to meet (1) distribution requirements, (2) no-acceleration-of-benefit requirements, and (3) election requirements.

The rules only permit distributions upon separation from service, death, disability, a fixed time specified in the plan, a change in ownership or control of the employer, or an unforeseeable emergency such as a severe financial hardship. Distributions at any other time will result in loss of income tax deferral.

The plan must not permit a prohibited acceleration of any payment or schedule of payments. Therefore, the plan administrator may not be given discretion over the timing of benefit payments that could result in an acceleration of payments

When Should the Deferral Election Take Place?

To achieve income tax deferral, the employee must generally make the election to defer compensation no later than the end of the preceding tax year.

In the first year of eligibility, the employee can make the initial deferral election within 30 days of becoming eligible and it will apply to compensation for services subsequently performed.

What’s the Conclusion?

Even with the tax law placing restrictions on the distribution of benefits, nonqualified deferred compensation arrangements remain an effective way to reward and retain valuable, highly compensated employees on a selective basis.

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