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PRESERVATION OF WEALTH

CONCENTRATED IN CLOSELY HELD C CORP


USING A FAMILY LIMITED PARTNERSHIP (FLP) &
AN EMPLOYEE STOCK OWNERSHIP PLAN (ESOP)

Dear

We are pleased to have had the opportunity to provide a feasibility


assessment of your family’s preparation for coordinating the
practices and operational process for the asset, entities and people
who will be involved in working with you to manage the
diversification of your closely held company stock.

This will begin with introducing you to the strategy, and the
business elements to support it. Then we will perform a discovery
of your current landscape of structures and people, time frame for
getting started, your budget for consulting work. This will be
followed by an onsite visit to discuss with employees and
executives the practices set up and operational processes plus
current systems and technology in use. The on site visit helps us to
understand any gaps, problems and challenges, prioritize solving
them and as well as identify the projects, priorities, budget to build
prior to strategy implementation .

Robin Coady Smith | 302.235.0234


Managing Partner

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FLPSOP®

STRATEGIC COORDINATION OF
A FAMILY LIMITED PARTNERSHIP (FLP)
AND AN EMPLOYEE STOCK OWNERSHIP
PROGRAM (ESOP)

1990-2004 ESOT Resources, Inc. All rights reserved. FLPSOP® is a registered trademark of
ESOT Resources, Inc.

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A TAX-ADVANTAGED STRATEGY AND
PLANNING TOOL FOR BUSINESS OWNERS

YOUR CHALLENGES

• Is 90% or more of your personal net worth is invested in the


highly appreciated stock of your closely held business?

• Do You understand the importance of diversifying some of


your stock? Do you know your choices?

• Is your basis in your stock mostly capital gains? How much?

• Are you willing to pay capital gains taxes to free up of share-


holder liquidity?

• Do you or would your family want to maintain voting and


operational control of your company? If it could be
possible to achieve diversification of your stock while keeping
control, would you?

• Do you risk liability exposure? How are you protecting


your hard earned equity value?
• Would you know how to compress the value of your assets by
30%, 40% or even 50% to reduce estate taxes?

FLPSOP®
An ideal tool, the FLPSOP® solves these challenges by
creating a tax advantaged, controlled market for closely held
stock. The FLPSOP® allows you to remain in full control of
your company. 100% of all costs for shareholder liquidity are
tax deductible corporate expenses and 100% of the stock sale
proceeds can be tax deferred during your lifetime and
eventually eliminated.

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A BUSINESS PURPOSE

C Corp
closely held
operating company

Family Capital Management Co.


AN OPERATING COMPANY WITH A BUSINESS PURPOSE
Manages the family interest in C Corp stock, other assets/entities,
directs business affairs of the FLP

•CLIENT RETAINS OPERATIONAL CONTROL


OF FLP AS MANAGING DIRECTOR OF FCM.
•CLIENT IS MAJORITY SHAREHOLDER OF FCM.

• ADULT CHILDREN ARE DIRECTOR/EMPLOYEES


AND RECEIVED SALARIES/BENEFITS.
• FAMILY AND SELECT STAFF MAY
BE SHAREHOLDERS.

FLP • NON-FAMILY ARE EITHER SALARIED


STAFF ONLY OR OFFICER/DIRECTORS.

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FLPS AND LLCS
ADD THE OPPORTUNITY FOR
POTENTIAL VALUATION DISCOUNTS

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WEALTH PRESERVATION
CAPITALIZING
THE FAMILY LIMITED PARTNERSHIP (FLP)
Client creates the FLP , appointing a newly formed ‘Capital Management
Co’ as the General Partner of the FLP. The GP retains the control interest.
in the FLP.
The Client transfers existing assets, including their closely held stock to the
FLP in exchange taking back the minority interest – discounted FLP Units

General Partner manages

PARTNERSHIP INTERESTS
• CONTROL INTEREST
FLP
• MINORITY INTERESTS – Marketable Securities
Minority interests may be eligible
Real Estate
for valuation discounts of 30%, 40%
or even 50% by a qualified
C Corporation stock
appraiser. Oil & Gas Interests
Discounts are for lack of Collectibles & Antiques
control and lack of marketability.
Valuation discounts increase tax-
free gifting and may decrease
estate and gift tax liabilities.

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THE FAMILY LIMITED PARTNERSHIP (FLP)

AS A BUSINESS ENTITY, A VALID BUSINESS PURPOSE


IS REQUIRED FOR THE FLP. IT MAY NOT BE CREATED
AND RECEIVE VALUATION DISCOUNTS IF IT EXISTS TO
RECEIVE DISCOUNTS ONLY.

FEATURES/BENEFITS:
• ASSET PROTECTION
An FLP is very effective in preventing seizure of assets by future
creditors. A creditor can not force liquidation of a partnership as a
means to collect on a judgment against a limited partner.

• VALUATION DISCOUNTS
The FLP enables valuation discounts of 30 to 50% for lack of
marketability and lack of control on the part of minority partners.
These valuation discounts can create potentially significant gift tax
and estate tax leverage.

• RETAINED CONTROL
The business owner retains operational control over the FLP via his
appointment as life time Managing Director of his FCM company.
This management company, in turn, serves as General Partner of
the FLP.

• INCOME SHIFTING
By gifting shares of FCM company to family members and if
if the management company is structured as an S Corp or LLC,
the business owner can shift FLP income to family members.

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PARTNERSHIP DISTRIBUTIONS

C Corp
closely held
operating company

Family Capital Management Co.


FLP income is paid in form of Salaries to Family Members

General Partner –
DETERMINES AMOUNT, Directs Business Affairs
TIMING AND FORM OF
DISTRIBUTIONS FROM FLP of Partnership

To FLP
Partners
via FCM CO
FLP in form of
salary.
Net Revenue

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ESOP
EMPLOYEE STOCK OWNERSHIP PROGRAM
-Shareholder Liquidity; Tax-deductible funding for

- Business Succession; Provides owner with


continuing management control

- Capital Investments; Finance capital in a manner both


deductible and depreciable

- Wealth Preservation; May reduce owners’ estate tax


by 40 to 50 percent; may reduce owners’ risk of loss
by offering tax-deferred diversification of closely-
held stock into a replacement portfolio of stocks
and bonds; may eliminate capital gains taxes on highly
appreciated, closely held stock.

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THE ESOP ELEMENTS OF AN FLPSOP

An ESOP is a tax qualified defined contribution retirement plan.


It is designed to invest primarily in the common stock of
sponsoring companies and corporations. It is financed with tax
deductible principal payments or a combination of 1) cash 2)
seller notes and 3) third party loans. It is also a tool of
corporate finance for sponsoring companies.

TAX ADVANTAGES OF ESOPS

FOR SPONSORING COMPANIES: 100% of all ESOP costs are


tax deductible business expenses. This includes principal
payments on credit facilities used to finance the ESOP stock
purchase and dividends on ESOP shares.

FOR SELLING SHAREHOLDERS: Eligible shareholders can


elect to defer capital gains taxes on the sale of closely held C
Corp stock to an ESOP. For business owners who have built up
significant equity values in their company, this provides the with
a way to cash out without having to pay capital gains taxes.

FOR EMPLOYEES: An ESOP gives employees the opportunity


to receive an employer-paid equity position in the company.
That equity value grows in a tax exempt environment.

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ESTABLISHING THE ESOP

C Corp
closely held
operating company

Family Capital Management Co.


manages the family interest in C Corp, Stock, other assets/entities,
directs business affairs of the FLP

ESOP shares
to participants

C Corp creates the


ESOP and makes
deductible deposits
ESOP

A tax qualified, deferred


contribution retirement plan,
providing retirement benefits
and
A controlled, tax advantaged
market for closely held stock.

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SHAREHOLDER EQUITY

ISSUES
C Corp PUT OPTIONS
closely held
TO ESOP SHARE-
2
operating company
HOLDERS

Family Capital Management Co.

ESOP STOCK PURCHASE


1 FORMALIZES BUY/SELL

FLP IS SELLING SHAREHOLDER TO ESOP


Put options enable
shareholders the right to
demand liquidity for their
3 ESOP shares at
Retirement, Disability,
Death or Termination.

ESOP
FLP FLP SELLS
C CORP At least 30%of equity value
STOCK TO must be owned by ESOP
Marketable Securities THE ESOP before Section 1042 rollover
Real Estate BASED ON becomes available. Rollover
C Corporation stock – BUY/SELLA securities purchased here
control interest shares GREEMENT
Oil & Gas Interests TERMS
Collectibles & Antiques

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EMPLOYEE STOCK OWNERSHIP PROGRAM
(ESOP)

• BUSINESS SUCCESSION ADVANTAGES


Create economic leverage by loaning tax free death benefits to
the ESOP. The ESOP acquires shares of company stock.
Eliminates concessions normally required in third party sales.
Eliminates capital gains taxes on the sale of highly appreciated,
closely held company stock.

• SHAREHOLDER LIQUIDITY & DIVERSIFICATION


The sponsoring company, in creating the ESOP incurs an obligation
to eventually repurchase ESOP shares when it comes time to pay
benefits to participants and beneficiaries.
In privately held companies, the IRS rules require the ESOP to provide
participants and beneficiaries with a series of put option
opportunities to convert their ESOP stock accounts into cash.
The strength of the sponsoring company’s ability to honor put options
in a timely manner is a critical cornerstone of ESOP share values.
For example, the stronger the ability to meet benefit payments,
the lower the valuation discount for lack of marketability and the
higher the potential sale price for the business owner.

• TAX ADVANTAGED INVESTMENTS


An indexed universal life policy is ideal for establishing a tax
advantaged, dedicated reserve fund to accumulate
cash for future ESOP benefit payments. In general, most companies
that sponsor an ESOP should deposit $50,000 to $60,000 per year
for every $1 million of stock owned by the ESOP. This is to create
the solid foundation for payment of ESOP benefits.

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IRC Section 1042 TAX DEFERRED ROLLOVER

A 1042 rollover is similar to 1035 exchange of ‘like’ property.

In a 1042 rollover, the selling shareholder* is completing a


tax deferred exchange of 100% of the fair market value of
their closely held company stock for a diversified portfolio of
publicly traded securities.

*Selling shareholder must be an individual, trust, estate or partnership. The


selling shareholder must have owned the shares that are sold to the ESOP for at
least 3 years prior to date of sale. It may be possible that the clients own holding
period for the closely held stock can be carried over the FLP and tacked on the
selling shareholder’s holding period.

PERMISSIBLE 1042 ROLLOVER INVESTMENTS –


qualified replacement property:
• equity or debt securities of US domiciled operating corporations, either publicly
traded or privately held.

Investments – NOT Qualified as Replacement Property:


• mutual funds
• real estate
• US Government securities
• Municipal bonds & annuities
• Life Insurance
• Promissory Notes
• Certificates of Deposit
• Savings Accounts
• Collectibles

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1042 ROLLOVER

Rollover is a deferral of capital gains tax. However, careful


planning is required to maintain the deferral and the
achieve the eventual elimination of capital gains tax.

Certain events can result, accidentally, or intentionally,


in a “disposition” which means a taxable event happens
that triggers payment of the deferred capital gains tax.

THE 4 MAIN TRIGGER EVENTS include:


• Sales
• Maturity
• Calls by the issuer
• Seizure of rollover investments by a judgment creditor

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BUSINESS SUCCESSION

C Corp
closely held
operating company

Family Capital Management Co.

BUY – SELL AGREEMENT FUNDING


C CORP TAKES COLLATERAL ASSIGNMENT
IN CASH VALUES & DEATH BENEFITS

IRREVOCABLE INSURANCE
TRUST

LOAN TAX FREE


$ TO ESOP TO
FLP PURCHASE
Marketable Securities REMAINING STOCK
Section 1042 Securities CASH
Real Estate
Control interest shares ESOP
of C Corp Stock
Oil & Gas Interests SHAREHOLDER’S
Collectibles & Antiques STOCK

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Partnership Entity
Administration

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Partnership Structure
Example

Current/Future Vehicles
Minority Partners

Client Limited Partnership


$ Contributions
Initial & future
Account 1
Operating Cash
Spouse Account

Limited Partnership
Child Account 2
Real Estate
Partnership
Child Distributions
Limited Partnership
Account 3
Tax Liability Majority Interest FCM

Limited Partnership
Account 4
Valuation 1042 Rollover Securities
of
Majority Partner
Partnership
Family Capital Units (NAV) Limited Partnership
Management Co. Account 5
Investment Portfolio
Taxable

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Inside the Partnership
Example
CUSTODY
EQUITY STYLES - % of portfolio
ALL CONTRIBUTIONS,
OPERATING ACCOUNT WITHDRAWAL, EXEPNSES
COME FROM HERE

Sample CASH FOR FUNDING


Sub accounts
Of Master ACCOUNT 2
Custody

ACCOUNT 4

ACCOUNT 5

INCOME & OVERDRAFTS


Income stays in account where earned until moved to the Operating Account.
Overdrafts are not cured by moving cash from cash for funding or operating account
Amortization/Accretions on bond portfolios adjust P to I or I to P of the
Bond portfolio sub account

EXPENSES
Custody, advisory or investment management fees comes from respective
manager sub account.
Miscellaneous expenses are allocated pro-rata across accounts.

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Partnership Basis Tracking
(inside vs. outside basis)
INSIDE OUTSIDE
BASIS BASIS

• REAL ESTATE
• BUSINESS UNITS OF
INTEREST
PARTNERSHIP
• MARKETABLE COST BASIS
COST BASIS
SECURITIES OF FLP UNITS?
OF ASSETS IS THE
REMAINS STARTING
THE NAV EITHER
ACTUAL $1 OR $10
BASIS ARE COMMON
VALUE OF UNITS
CHOICES
VALUATION OF
PARTNERSHIP IS IS BASED ON NAV
MARKET VALUE OR OF
APPRAISED VALUES SECURITIES HELD
INSIDE THE FLP

FLP FCG ENTITIES

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Necessary
Supporting Services

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Accounting Hub

The diversity of investments and non financial assets as well as


entities involved in today’s wealth transfer or wealth management
strategies requires an integrated hub of accounting software in order to
accurately account and report, as well as to provide accurate
statements to shareholders and stakeholders.

Accounting systems may include any one or more of;

• General Ledger
• Partnership Accounting
• Financial Accounting
• Investment Accounting
• Trust Accounting

As well, systems also include integration of systems and spreadsheets


that ordinary would not see each other or share information or data
with an interface.

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General Ledger

A general ledger is highly necessary to track the many items of data


and transactions related to non publicly traded assets as well as debits
and credits to and from general ledger categories of the business.

A general ledger is the cornerstone of accuracy of an accounting hub in


both operating businesses, as well as the business of family wealth
management in either a family office, a capital management firm or a
private family trust company, as best fits each case.

A general ledger must often integrate with other accounting systems


such as partnership accounting, investment accounting or trust
accounting

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Partnership Accounting

Reporting Needs of the Partnerships


• Monthly liquidity
ƒ Monthly valuation of NAV
ƒ Monthly valuation of Partners’ Capital Account

Due to the complexity of many partnerships, partnership accounting is


highly necessary to track the many data points which may come from
a general ledger or either manual or aggregation of data from many
different sources.

The appropriate data should automatically load into the partnership


accounting software. Partnership accounting will maintain the
percentage of each partnership owned by each other partnership entity,
individual or trust. The frequency of updates will be based on the
nature of the non-publicly traded assets held in one or more
partnerships. It is not uncommon for non-publicly traded assets to be
priced annually.

The partnership accounting will facilitate preparation of K-1s for each


partnership.

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Master or Unitized
Custody Services

Operational and Administrative Services

Custodians take on many different forms and provide different levels of


service. Some firms provide custody at seemingly no cost. This does not
mean one custody service is the right fit in all arrangements.

Custody performs the following services:


• Safe keep securities
ƒ Process security purchases, sales, and deliveries
ƒ Collect and post interest, dividends, and other payments
ƒ Maintain detailed records of transactions and portfolio holdings
ƒ Deliver comprehensive account reports, on line access, on line statements
ƒ Automatically sweep cash balances into desired short-term investment
vehicles
ƒ Monitor and collect both ordinary and extraordinary trustee fees and
investment manager fees
ƒ Provide tax information to the client and investment manager on a periodic
basis, including 1099s at year-end

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Income
Tax Returns

• Personal tax return preparation and filing will be prepared by your


tax preparer. A detailed K-1 from the partnership will be provided
to the beneficiaries by at the beginning of each new year.

• Partnership accounting and tax reporting should be the responsibility of


of an experienced accounting firm with demonstrated experience in
handling accounting and tax preparation around partnerships.

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